How foreclosure impacts your wallet - and how to recover(Read article summary)
Foreclosure is a grueling experience that can have a lasting impact on your finances and your credit score. But with time, you can rebuild your financial profile.
J Pat Carter/AP/File
You're about to lose your home to foreclosure. Will it destroy your credit? Unfortunately, yes — your three-digit FICO credit score will plummet following, and leading up to, a foreclosure.
There is hope, though. Even after a foreclosure, you can rebuild your credit score. You'll even be able to qualify for a mortgage loan again one day. Just be prepared to wait.
"If there is a bright side to foreclosure, it is that credit scores will recover with time and reestablishing a good payment history," said J.D. Crowe, president of Lawrenceville, Georgia-based Southeast Mortgage and president of the Mortgage Bankers Association of Georgia. "The most important thing for people to know about a foreclosure absolutely, without question, is to always pay everything on time, especially a mortgage payment."
The Credit Score Drop
Lenders of all kinds rely heavily on your FICO credit score to determine whether they should approve you for a loan, and at what interest rate. If your FICO score is too low, lenders will hesitate to loan you money. When they do, they'll charge you higher interest rates to make up for the risk.
Today, most lenders consider a FICO score of 740 or higher to be a good one, indicating a borrower with a history of paying bills on time and not running up too much credit card debt.
How far will your FICO score drop if you suffer a foreclosure? There's no one single answer. The actual fall your score takes depends on what your score was before you went through foreclosure, how many missed mortgage payments you accumulated, and whether you had any other missed payments on your credit reports.
In general, though, a foreclosure will drop your credit score by at least 100 points — usually more. And typically, consumers' credit scores have already taken a hit before foreclosure. That's because they usually miss several mortgage payments before lenders start the foreclosure process.
Crowe estimates that depending on your individual circumstances, your FICO credit score will fall by 100 to 300 points. If you started with a solid 750 score, it could fall to the low 500s by the time your foreclosure closes.
That foreclosure will remain on your credit report for seven years. This means that borrowers will see it every time they pull your credit during this period.
Waiting for Another Mortgage
Don't plan on applying for a new mortgage anytime soon after a foreclosure. First, your credit score will probably be too low. Secondly, mortgage lenders impose mandatory waiting periods for borrowers after a foreclosure.
If you want to apply for a conventional mortgage loan — one not insured by the federal government — you'll have to wait at least seven years after a foreclosure. You might be able to qualify for a conventional loan after just three years if you can prove extenuating circumstances led to your foreclosure, such as a job loss, illness, or divorce. However, Crowe said that it is very rare for lenders to shorten the mandatory waiting period no matter what you list as the cause of your foreclosure.
If you want to apply for a loan insured by the Federal Housing Administration, better known as an FHA loan, you'll have to wait three years from your foreclosure. However, if you can prove that a job loss led to your foreclosure, you will only have to wait one year to apply for a new FHA loan. You will have to prove, though, that the job loss reduced your regular income by at least 20%. You'll also have to provide documents showing that your income has since returned to its previous level or higher.
You can apply for a loan insured by the U.S. Department of Veterans Affairs as soon as two years after your foreclosure. But you do have to meet the eligibility requirements to qualify for a VA loan.
Rebuilding Your Credit
Once your score has fallen, it's time to start rebuilding. You can do this by paying all of your bills on time and cutting down on credit card debt. Don't close any unused credit cards, though. Having available credit that you aren't using actually improves your credit score.
Over time, your score will slowly improve. And lenders will care less about your foreclosure as the years move on, as long as you don't make any other late or missed payments.
Eventually, and usually before the seven-year wait for foreclosures to fall off your credit reports, you will again be able to qualify for auto loans, credit cards, and other loans as long as you show that you are now managing your finances responsibly and paying your bills on time.
"If you have had a foreclosure, accept responsibility, pick yourself up, and move on with your life," Crowe said. "It is not the end of the world. What you must do from this point forward is to pay every creditor on time."
This article first appeared at Wise Bread.