Impact of Foreclosure or Short Sale on your Credit Score
Irreparable damage is done to your credit rating when you experience a short sale or some of the other related possibilities– not as bad as foreclosure or bankruptcy, but are damaging nevertheless. However, most of the agencies and people of less repute will never take the trouble to tell you the far-reaching consequences of foreclosure or foreclosure on your credit standing.
A foreclosure, as you would have sensed, can damage your credit rating for a long time. A foreclosure or a short sale can impact your credit standing for as much as 7 long years and also setting you back immediately by a whopping 200-300 points on your FICO credit score. A short sale of your property, as a response to avoiding foreclosure, can also cause your credit rating to drop considerably and can set you back about anywhere from 55 to 125 points on your FICO score – this might show up as “foreclosure arrangement”, or “debt settlement”. Additionally, a deed-in-lieu might just be as lethal as a foreclosure itself since it entails a transfer of ownership.
Foreclosure is always best avoided. It might allow you to stay rent free for a while until you will be asked to leave, but the negative consequences a foreclosure has on your credit rating – which implies that your ability to avail credit for important things like student loans and car loans etc is severely affected because that’s how severe FICO along with potential lenders take this event to be.
Often overseen, but a critical aspect that should help you choose between a foreclosure or a short-sale, is the tax part of it all. IRS considers any discharged debt as an income and hence you will be taxed on that. For instance, if you declared bankruptcy due to foreclosure of a property worth $300,000, this debt which is now discharged by bankruptcy is considered income and you will now have to pay tax on that amount. A short sale, on the other hand, causes your debt to be forgiven – the difference between the mortgage amount and the amount the lender sold it for. This forgiven debt is also taxable.
Another aspect to consider when choosing a foreclosure vis-à-vis a short sale is how long a homeowner can wait before buying another home or being able to avail a new home loan. Most homeowners think that short sale will let them avail a new home loan in a short time period, which is unfortunately not the case. A set of guidelines from Fannie Mae, stipulate that individual home owners must wait out for at least 24 months before they would be considered for new home loans. It might also help to remember that in the event that the short sale generates much lesser an amount than the mortgage due, the lender can proceed to file a deficiency judgment which is like a thorn in the wound and something the homeowner has to battle with again.
Nothing is as easy as it might first sound and a homeowner must look into all possible options before settling with any one option. Hearsay and casual advice should never be paid attention to. Think creatively and take help from competent professionals to arrive at customized solutions that would bail you out of this problem fully. You might want to transfer ownership to an investor by signing a deed but bring your mortgage payments up to current from the proceeds that came from dissolving your equity. More such solutions are possible when you approach it the right way.
How to Rebuild Your Credit After a Foreclosure or Short Sale
If you’re one of the millions of Americans who experienced either a foreclosure or short sales due the housing downturn, you might be left wondering where to go from here, when it comes to rebuilding your credit score.
Here is the information you must know about your credit, to best recover from a foreclosure or short sale.
Though you may be relieved to have finally resolved your housing situation, don’t put it out of your mind just yet. Keith Gumbinger, mortgage expert for HSH.com says that knowing the final terms of the arrangement made with your lender plays a role in rebuilding credit. That’s because different defaulted home loan terms come with different ramifications to your credit score. Know whether you had a short sale (the lender allows you to sell the house for less than the balance on the mortgage, and may or may not require you to make up the deficiency), an involuntary foreclosure (you stopped making payments and the property, and potentially your assets, were seized), or you negotiated a deed-in-lieu of foreclosure (a voluntary process in which you “hand over” the deed to the lender, shortening the process and accompanying expenses), as well as the specific terms were agreed upon. When it comes to foreclosures and short sales, no two agreements are alike; the terms and conditions have different impacts on credit scores, how they are reported to the credit bureaus, and how long they take to “fall off.”
While short sales are often perceived as more “favorable” when it comes to defaulting on a home loan, FICO conducted a study simulating the aftermath of a foreclosure and a short sale, and revealed that in regards to credit score impact, there isn’t much difference between the two events. The real gauge, it seems, is in the starting credit score before the default took place.
FICO examined three hypothetical consumers with starting credit scores of 680 (customer A) 720 (customer B), and 780 (customer C). It found that despite whether the loan default was a short sale or foreclosure, customer C’s credit score was most impacted, indicating that the higher the credit score, the longer it takes to restore. Further, time is critical in rebuilding credit worthiness: a short sale with no deficiency balance will generally require at least three years before the credit score will increase. In the case of a foreclosure, the borrower must wait for at least seven years, and in some cases, up to ten, if a bankruptcy filing was involved.
After you have completed the foreclosure or short sale, request your credit report from Annualcreditreport.com, which allows you one free credit report each year. Confirm that the report does not contain any errors, or reflect old debts that were paid off, and report any disputes to Experian, TransUnion and Equifax immediately. Ornella Grosz, author of Moneylicious: A Financial Clue For Generation Y says that one way to add points to your credit score is by paying off or lowering your existing credit card balances, and that “about 30 percent of your credit score is made up from keeping balances low. The lower your debt-to-income ratio, the better.” John Ulzheimer, Mint’s credit columnist, also addresses this the post What Kind of Debt Pay-Off Boosts Your Fico Score Most.
Set up automatic bill pay on all of your existing credit accounts to make certain that creditors are always paid on or before the due date (don’t play with grace periods when you’re trying to rebuild credit). Or use the “Bill Reminders” feature on your Mint.com account. If you have missed payments in the past, commit to starting good habits now. You can rebuild a score by paying every bill on time. On the contrary, skipped or late payments will reduce your credit score further. Don’t attempt to raise your credit score by closing open credit lines, and know that removing the credit availability might actually hurt your score more after a short-sale or foreclosure, when access to new credit will be limited. (To potential lenders, closing the credit, even it you haven’t used it in years, makes it appear as though you are closer to being “maxed out” than you really are).
If you are left with no credit lines after the foreclosure or short sale and cannot find unsecured lines of credit, apply for a secured credit card, which are offered by many financial institutions and credit unions. Secured cards will require you to deposit funds with the creditor, in exchange for a credit card with a credit line of the same amount. (For example, if you put $500 down, that will be the amount of your secured credit line). If you use secured cards responsibly, they will help to slowly increase your credit score. Over time, the lender may raise your line of credit for “good behavior,” and eventually, you’ll be a candidate for unsecured credit again. However, Grosz cautions to read the fine print in the agreement for all secured cards, and confirm that you will not be charged additional fees for use.
Rebuilding credit after a short sale or foreclosure can be frustrating, but it is a process most impacted by being patient. Amber Stubbs, senior managing editor at Cardratings.com says “the more time passes, the less a black mark affects your credit, and you won’t be able to make a full recovery until the derogatory item is off your credit report. Most derogatory items, including foreclosures, fall off seven years after the last activity on the account. If you manage other accounts responsibly while you wait, you should be in good shape by the time the foreclosure disappears from your credit report.”
Stephanie Taylor Christensen is a former financial services marketer based in Columbus, OH. The founder of Wellness On Less, she also writes on small business, consumer interest, wellness, career and personal finance topics.