The housing market correction was brutal. If you are one of the millions of people considering foreclosure or a short sale, you need to read this post first and understand all the consequences before proceeding. If you are already in foreclosure or going through a short sale, then you should check your latest credit score and figure out how to climb out of purgatory.
A foreclosure and a short sale have similar negative hits on your credit score. A foreclosure is generally worse because you are not working with your bank whom you owe money to settle your debts. A short sale, on the other hand is debt forgiveness. Your bank agrees to forgive the difference between the sale and what you owe. Just be aware you will probably have to pay taxes on your deficiency. There is no free lunch.
Once your credit score gets trashed, it takes anywhere from three to seven years to fully recover. Sometime your score may never fully recover at all. With all the questions I’ve received on the subject, and my own temptation of letting one of my vacation properties go during the economic crisis, this post should help you weigh the pros and cons of foreclosure or a short-sale. The information is gathered from our friends at FICO, two real estate lawyers I spoke to, my own experience, and thoughts from several mortgage officers.
How Much Will Your Credit Score Get Hit In A Foreclosure?
According to FICO, if your credit score is 680, a foreclosure will drop your credit score on average by 85 to 105 points. If your credit score is excellent at 780, a foreclosure will drop your score by 140 to 160 points. In other words, the higher your credit score the more it will get smashed! High credit score holders must think much more carefully before foreclosing or conducting a short-sale. My TransUnion credit score dropped from 790 down to 685 during my tenant’s $8 non utility bill payment debacle a couple years ago, so I completely believe FICO’s figures.
Here’s a brief summary of averages from Fair Isaac:
- 30 days late: 40 to 110 points
- 90 days late: 70 to 135 points
- Foreclosure, short sale or deed-in-lieu: 85 to 160
- Bankruptcy: 130 to 240
It’s really hard to get much lower than 500 (out of 850) on your credit score even if you tried. If you do have a poor credit score, find solace knowing that banks will equally deny someone a loan or refinance for scores up to ~650. The main reason is there are enough 650+ credit score holders lining up to borrow money that it’s not worth taking the credit risk on lower credit score individuals. If you have a poor credit score, the alternatives are borrowing from your 401k, from friends, or through Prosper Loans. Prosper allows you to consolidate your debt with interest rates as low as around 7% compared to 15%+ for credit cards.
How Long Will A Foreclosure Stay On Your Credit Report?
A foreclosure will be on your record for 7 years on average, plus 180 days from the last time the account was paid as agreed. The public record would have its own opening date (the date the foreclosure was filed at the courthouse) and would show for 7 years from the date of the disposition. Your credit score will gradually improve over these seven years, but not fully until the foreclosure is off your record.
Those who’ve been through foreclosure and want to do conventional financing in the future will have to pay a higher interest rate (approximately 1 and a half to 2%) unless they put a sizable downpayment on their new property (more than 20% down). Given you’ve just gone through this terrible experience of foreclosure, I suggest not bothering with taking on debt until the foreclosure has been removed from your credit report. Give yourself a chance to breath without debt.
When Will My Mortgage Company Start Reporting Late Payments?
Your mortgage holder will begin negative reporting to the credit bureaus the first time you are 30 days late with your mortgage payment. Therefore, before your foreclosure even begins, you will have negative marks on your credit, bringing your score down. Most banks wait until you are 90 days behind in your payments to begin foreclosure proceedings, which often take two or three months to complete. By the time your foreclosure is actually finalized, you will find that your credit score is reflecting six months of missed payments; this can take your score down by up to 200 points.
Depending on whether you live in a recourse or non-recourse state, you could be held liable for the difference between what the bank gets for the property in foreclosure and what you owe in mortgage. This is called the “deficiency.”If you are in a recourse state, the bank has the right to go after your other assets to make up the difference. If you cannot pay the difference between what you owe and the sales price (upside down mortgage), you might have to file for bankruptcy which is extraordinary painful on your finances, mental health, and ultimately happiness.
Considerations Before Foreclosing
1) Check whether you live in a non-recourse state. Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah, and Washington are considered non-recourse / anti-deficiency states, but double check anyway. There are states such as California, Idaho, Montana, Nevada, New York, and Utah who are permitted a single lawsuit to collect mortgage debt. They need to choose between foreclosing or suing to collect debt. Furthermore, if you refinance your loan or take out a second loan, your non-recourse loan can turn into a recourse loan. The richer they think you are, the higher than chance a bank will go after you. Always check with a lawyer.
2) Assess your financial situation. Can you pay the mortgage or do you just not want to pay the mortgage? If you just don’t want to pay the mortgage, then you’ve got to think what a badly damaged credit score means to your future. A bad credit score could hurt your employment opportunities as more and more employers check your credit score. Employers are much more demanding of candidates in this competitive labor market. A bad credit score will cause for much higher rates for a car loan you shouldn’t get, a credit card you should sign up for, and a new property you shouldn’t buy. Seriously ask yourself whether you can do without credit and have a black mark on your account for seven years before going into foreclosure.
3) Assess the future of the property market in your area. The property market is finally on the upswing in 2013, however, each location is different. Talk to your local realtors, homeowners, landlords, economics, and bankers to get their opinion. Got to several open houses and see for yourself what’s going on. If you think your house can recover back to your original purchase price within 5 years and you can afford the payments, do not foreclose or short-sale. Remember, your foreclosure will be on your credit report for 7 years. Make sure your living situation is congruent with your real estate outlook.
CAREFUL BEFORE YOU DECIDE TO FORECLOSE
A foreclosure or short sale will crush your credit score for seven years and potentially ruin your future as well. If you have already foreclosed then stop the bleeding by making sure all other bills are paid on time. Perform great work at your existing firm. Build alternative income streams so you have the optionality in case something else bad happens.
Carefully weigh the pros and cons of doing a foreclosure before proceeding. If you have two people on the deed, know that both owner’s credit scores will be negatively affected. If you are already 30 days late or more on your payments, check your credit score and call the bank to see if you can work something out. Right now is the perfect time to negotiate with your bank with all these multi-billion dollar settlements with the US Department of Justice for “robosigning” and wrongful foreclosures. If you wait until you are 90 days late, there is no turning back.
* Check Your Experian Credit Score Today: Check your latest Experian credit score straight from their website. Experian is the most commonly sourced of the big three. It’s a good idea to see what your credit score is before applying for a loan. If it’s below 720, you won’t get the best rate, but at least you can spend time to improve your score. Furthermore, 1 out of 4 credit reports have errors, negatively affecting one’s credit score. I had a $8 late electric bill that crushed my credit score by 100 points and almost derailed my mortgage refinance. The scary thing is, I had no idea! A FTC study reported that roughly 25% of credit reports have inaccuracies.
* Shop Around For A Mortgage: LendingTree Mortgage offers some of the lowest refinance rates today because they have a huge network of lenders to pull from. If you’re looking to buy a new home, get a HELOC, or refinance your existing mortgage, consider using LendingTree to get multiple offer comparisons in a matter of minutes. Interest rates are back down to ALL-TIME lows due to tremendous volatility and uncertainty in the markets. When banks compete, you win.
* Look into real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, can’t qualify for a mortgage, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today. Real estate is a key component of a diversified portfolio. If you study the asset allocation mix of college endowment funds and high net worth individuals, you’ll see real estate weightings of anywhere between 5% -25%. Real estate crowdsourcing also allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates around around 4% – 5% in San Francisco, but over 10% in the Midwest if you’re looking for strictly investing income returns. Check out my Fundrise review as well.
Updated for 2017 and beyond.