How Does Foreclosure Effect Your Credit Rating?

There's no question — your credit rating takes a hit if you foreclose on your home. Late mortgage payments, short sales and deeds in lieu also make a negative impact.

If you're experiencing hard economic times and are faced with the reality of one of these options, take heart: The damage is not permanent. With time and patience, you can rebuild your credit rating. Here's how foreclosure, short sales, deeds in lieu and late mortgage payments affect your credit rating, and how you can repair the damage.

• Foreclosure: Your credit score can drop by as much as 200 to 300 points if you're forced to give your home up to foreclosure. This drop carries with it a ripple effect that impacts your ability to purchase a new home and obtain car loans, credit cards, even insurance. Are you looking for a new job? Then be aware that some prospective employers refer to credit scores as an indication of personal responsibility. You may be passed over if employers perceive you as untrustworthy based on your financial history. All is not lost, however, if you keep your other financial obligations in good standing. Foreclosure can remain on your credit report for as long as seven years, but its effect will diminish over time —  perhaps in as little as two years — if you keep other credit balances low and make all your payments on time.

• Short sales and deeds in lieu: FICO, the most popular credit scoring model in the United States, conducted a study of the impact of foreclosures, short sales and deeds in lieu on credit scores. It found that short sales and deeds in lieu affect credit scores as negatively as foreclosures. Since these options also represent a mortgage loan default, any lenders you may wish to do business with in the future could judge a short sale or deed in lieu as equally damaging evidence of your inability to pay your debts. However, some may consider a past short sale more favorably than a foreclosure; it all depends on the lender.
• Late payments: Late mortgage payments (even one month’s worth) reflect a homeowner’s ability to pay debts. FICO’s study shows that being only 30 days late on your mortgage payment triggers a significant drop in your credit score. You should contact your lender immediately to work out an alternate schedule if you expect to miss a payment.

The impact of a foreclosure, short sale or deed in lieu could be less severe if your current mortgage lender does not report a deficiency balance on your loan to credit reporting agencies. (A deficiency is the difference between your unpaid mortgage balance and the proceeds from a foreclosure, short sale or deed in lieu.) However, it will take time to recover completely from any of these options, whether or not a deficiency appears on your credit report.