Foreclosure, Deed in Lieu of Foreclosure, Short Sale, and Bankruptcy can all have long-lasting impact on an individual’s ability to obtain credit. Homeowners need to get the facts before making critical decisions that will impact their lives for many years to come. In this series of seven blogs, I’ll be examining each of these options in detail so you can get a better understanding of the myths and realities surrounding them and how they affect your credit.
Foreclosure is the legal process by which a bank or other secured creditor either sells or repossesses a parcel of real property, home or land after the owner has failed to comply with the mortgage or deed of trust agreement with the lender. Most frequently, the violation of the mortgage agreement is the default of payment. The completion of the foreclosure process allows the lender to sell the property and keep the proceeds to pay off the mortgage as well as any legal costs. The length of the foreclosure process varies from state to state.
If the foreclosed property is sold for less than the remaining primary mortgage balance, and there is no insurance to cover the loss, the court overseeing the foreclosure process may enter a deficiency judgment against the borrower. Deficiency judgments can be used to place a lien on the borrower’s other personal property, obligating the borrower to repay the difference or suffer the loss of one’s property. It gives the lender a legal right to collect the remainder of debt out of the borrower’s other existing assets.
However, there are exceptions to this rule. If the mortgage is classified as “non-recourse debt,” then in the event of foreclosure the borrower has no personal liability. This is often the case with residential mortgages. If so, the lender may not go after the borrower’s personal assets to recoup additional loss.
The lender’s ability to pursue a deficiency judgment can be restricted by state laws. In California and some other states, original mortgages (the ones taken out at the time of purchase) are typically non-recourse loans; however, refinanced loans and home equity lines of credit are not.
If the lender chooses not to pursue deficiency judgment-or can’t, because the mortgage is non-recourse-and writes off the loss, the borrower may have to pay income taxes on the un-repaid amount even if it can be considered “forgiven debt.”
Any other loans taken out against the property being foreclosed (second mortgages, home equity lines of credit) are “wiped out” by foreclosure (in the sense that they are no longer attached to the property), but the borrower is still obligated to pay them off if they are not paid out of the foreclosure auction’s proceeds.
How Does a Foreclosure Affect Credit?
A foreclosure can be reported as a Foreclosure or Repossession and carries the most negative penalty on a credit score just under a public record (i.e. bankruptcy, tax lien, or judgment.) There is a misconception that foreclosures are considered public records to the scoring system. However, they are not. Although there is a Public Notice Record on file once a foreclosure is started, this record is completely different than a credit report public record.
Unless a foreclosure becomes a public record, such as a judgment, it can only be reported on a credit report for 7½ years from the date of the first late pay that led to foreclosure. Many consumers and lenders believe that it is 7 years from the completion date of the foreclosure process, but that is inaccurate. A foreclosure falls under the same rules as a collection, charge-off, or other similar action. I discuss the 7-Year Reporting Period and Statute of Limitations in great detail in my book, The Big Score.
A foreclosure can drop credit scores from 50-250 points (this includes points already lost due to delinquent payments). The difference in point loss depends on how many points someone has to lose in the payment history factor of his or her credit report. Thus if someone has a 750 credit score and they opt to foreclose, their score could drop up to 250 points. However, if someone has a 600 credit score, they may only lose 100 points for the same derogatory.
If a deficiency judgment or tax lien is filed in connection with a foreclosure, credit scores can drop an additional 100 points.
How Long Before You Can Buy Another Home After Foreclosure?
The current guidelines from Fannie Mae & Freddie Mac state that the waiting period for a foreclosure is 5 years from the date the foreclosure proceeding is completed.
However, if extenuating circumstances caused the borrower to enter into a foreclosure proceeding, such as the sub prime mortgage crisis fallout, loss of employment or a severe medical crisis, the waiting period, if approved, is 3 years from the date the foreclosure proceeding is completed.
The waiting period for an FHA backed loan is 3 years from the date of trustee sale.
For borrowers who engage in a strategic default foreclosure, you could be facing a 7 year waiting period with Fannie Mae and a lifetime ban from FHA backed loans.
Recovering Your Credit After Foreclosure
- My Free Special Report, Save Your Credit – Save Your Life is a great place to start! Click here to learn more.
- My Book, The Big Score – Getting It & Keeping It will give you the knowledge and the tools you need to Recover and Rebuild from any credit crisis. Even if you have great credit now, this book will help insure that it stays that way. Click here to learn more.
When it comes to foreclosure and how it affects the ability to obtain credit in the future, there are multiple points of extremely negative impact, including deficiency judgments for the amount not collected by the lender and a high risk that the borrower will be hit with a substantial tax penalty which can result in a tax lien. As a general rule, other than a bankruptcy, foreclosure is the least desirable of all of the options available when a borrower is upside down in a home mortgage.
One technique some people use to avoid foreclosure is called a “deed in lieu of foreclosure.” We’ll take a look at that next time!
Click here to read Part One of this series: No Laws Requiring Lenders To Report To The Big Three