Does a Foreclosure Impact Your Credit Score?
By Space Coast Daily // February 24, 2022
Foreclosure impacts homeowners and borrowers in a variety of ways. In addition to losing one’s home, a foreclosure will also affect one’s credit and, thus, credit score. A poor credit history generally translates to difficulties when borrowing money, qualifying for employment, or renting an apartment or house.
Homeowners, who are facing a foreclosure action, should seek help with foreclosure defense, to ensure they reach for and obtain the best possible outcome, given the facts and circumstances of their situation.
Foreclosure most commonly refers to the actions required for a lending institution to take legal possession (and title) of a property when a borrower fails to meet their agreed-upon monthly mortgage payments. A foreclosure is a type of legal procedure that permits a mortgagee/lender to take possession of the subject property to recover as much of the unpaid mortgage balance through the sale of the foreclosed property.
When Does Foreclosure Begin?
The criteria for foreclosure vary from state to state. The differences that exist between state jurisdictions may include variations in redemption periods, mailing or notice requirements, and scheduling protocols when auctioning the subject property.
However, a foreclosure action is typically triggered by a defined event. The following are the other potential triggers that are typically delineated in the recorded mortgage/note –
■ Violations of any Mortgage Provision.
A violation of any contract provision may be grounds to begin a foreclosure action. For example, a homeowner must maintain the subject property in an acceptable or satisfactory condition as part of the mortgage contract’s obligations. Another example that would be considered a contract violation (that may result in foreclosure) is the transfer of the property’s ownership from the borrower to someone else. A foreclosure may resolve both examples.
■ Unpaid Property Taxes.
Property taxes that are not paid through an escrow arrangement with the bank, must be kept current by the borrower/homeowner. If the property taxes become delinquent, a lender has the option to pay the outstanding taxes to avoid the potential legal actions available to the government as they attempt to recoup their losses. If a mortgagor does not reimburse the lender for these back taxes, the lender has the option to foreclose.
■ Homeowners Insurance Coverage That has Lapsed or is Not Current.
Borrowers are required to maintain adequate insurance (usually, the loan balance is the defining bare minimum) on the subject property. Insurance coverage carried by a homeowner that fails to meet the minimum requirements could be grounds to begin a foreclosure action.
■ Homeowners Association Fees are Past Due, If Applicable.
Homeowners living in a condominium or planned unit development (PUD) will have a monthly or quarterly payment payable to the community’s board or oversight organization. The monthly payments are collected from all owners and used to maintain common areas throughout the PUD or condo project.
As the authorized entity, the homeowners’ association may ask for the court’s assistance to collect unpaid fees from unit owners that are delinquent. Note that this type of foreclosure may proceed, even if the borrowers are current on their mortgage.
■ 3 to 6 Months of Mortgage Payments are in Arrears or Delinquent.
If a borrower misses three monthly payments for their mortgage, a lending institution has the option of recording a public notice that indicates –
■ The borrowers have defaulted on the recorded lien.
■ The pre-foreclosure process has begun.
Depending on the jurisdiction, a lender then mails the borrowers a default notice (aka, a Lis pendens, which is Latin for suit pending). This notice advises that the borrower is being provided a three-month grace period. During this time, the borrower must –
■ Bring the mortgage current and repay all arrears and associated fees, or,
■ Work with the lender to create a mutually agreeable arrangement regarding the unpaid and future payments.
When the three-month grace period comes to an end, the lender publishes a Notice of Trustee Sale to acknowledge that the subject property will be sold at auction. The timing requirements for this notice are generally 21 days, although there are variations to the law contingent on the state in which the property is located.
When the homeowner or borrower defaults on their mortgage, the next step is foreclosure.
■ A Judicial Foreclosure
Judicial foreclosure is a type of foreclosure that is available in every state and even required by certain states. With a judicial foreclosure, the lender initiates foreclosure by filing suit with the relevant judicial system.
This notice provides the borrowers (who are currently in default) with a formal demand and 30 days to bring the loan current if they are to avoid the impending foreclosure. If a borrower does not bring the loan current, the subject property will be sold in a local sheriff or court auction.
■ A Statutory Foreclosure or Power of Sale Foreclosure
This type of foreclosure is available in many states, provided that the guiding mortgage document contains a power of sale clause. In a power of sale foreclosure, lending institutions issue demand notices when borrowers go delinquent. If the mortgage remains delinquent during the established waiting period, the lender then begins the process that ends in foreclosure, and ultimately, a public auction.
■ A Strict Foreclosure
Strict foreclosures are permitted in a limited number of state jurisdictions. Strict foreclosures involve the filing of a lawsuit by a lender against a delinquent borrower.
The court provides the borrower with a period in which they must bring the loan current. If the mortgagor fails to pay the outstanding arrears, the mortgagee takes over the property directly. Strict foreclosures typically happen when the borrower is underwater when the outstanding debt exceeds the current property value.
How Foreclosure Impacts Credit Scores
As one would expect, foreclosure negatively impacts one’s credit score, but not as much as bankruptcy. Note: however, that any available legal avenue for solving borrower delinquency issues – a short sale or a deed in lieu of foreclosure, will generally have the same impact on one’s credit score.
A foreclosure usually causes a drop in a borrower’s credit score by approximately 100 points. An internal study by FICO compares how a foreclosure will likely impact two different credit profiles –
■ Excellent Credit – A borrower with a 780 credit score prior to foreclosure will likely drop 140 to 160 points after the foreclosure.
■ Good Credit – A borrower with a 680 Excellent Credit prior to foreclosure will likely drop 85 to 105 points after the foreclosure.
As noted above, the higher the credit score when foreclosed upon, the larger the impact on the borrower’s credit score.
What is the Length of Time a Foreclosure Stays on a Credit Report?
A foreclosure entry hits a borrower’s credit report within a month or so after the lender initiates the foreclosure process. The recorded foreclosure remains on a credit profile for seven years.
The expiration clock begins ticking from the date of the first delinquent payment – the proximate cause of the foreclosure. After 84 months (or seven years), the foreclosure entry drops from the credit profile.
Foreclosures typically begin after a borrower misses a minimum of four consecutive mortgage payments (or 120-day delinquency). These missed payments tend to impact a borrower’s credit score more than most negative items.
For this reason, by the time the foreclosure hits the credit profile, a borrower’s credit score has already taken a significant hit from these previously recorded arrears. Note that if a borrower is delinquent on obligations and debts (other than the mortgage), these other delinquencies have the potential to create a negative compounding effect on one’s credit score.
Why it’s Challenging to Know The Exact Credit Score Reaction to a Foreclosure.
From a logical perspective, it is simple to understand that a negative credit item that posts to one’s credit profile will cause a drop in the borrower’s score. However, it is much more challenging to know the exact number of points that will fall when foreclosure hits the credit data.
These are some of the reasons that may influence the size of the credit hit –
■ The systems and algorithms that have been used to calculate credit scores evolve over time.
■ Credit score modeling varies because different companies use proprietary algorithms.
■ Scoring algorithms are not shared with the public, which creates much confusion for the average consumer.
■ Credit scores are based, in part, on comparisons of one’s financial behavior with the choices made by other similar consumers. If credit practices of these comparable consumers change, this will indirectly impact others.
■ Economic and market conditions may change, leading to a revised monetary policy and a modified lending climate.
Most borrowers who face a foreclosure have shown signs of financial difficulties before foreclosure is even mentioned. Apparent signs of struggling borrowers include late payments, nonpayment, or partial payment, among others.
When a borrower misses a mortgage payment, it creates a delinquency that is reported to the credit agencies. The credit bureaus update a consumer’s credit record with this new information when received. The lender would report a late payment as a 30-day late payment for the first delinquency.
If a borrower misses the next payment as well, the credit report would now reveal two mortgage delinquencies, as follows –
■ A 30-day delinquency for the current payment that is due.
■ A 60-day delinquency for the payment that went unpaid in the last month.
According to FICO, a borrower’s credit score has the potential to drop 50 -100 points when the creditor reports that a consumer’s monthly obligation is 30 days overdue. Each reported delinquency by the creditor further damages a consumer’s credit profile and thus, lowers their score.
Again, it is worthy to repeat, that if a consumer’s credit scores were high at the time of the delinquency or default, it is likely that these consumers will see a larger decrease in their scores compared to other consumers with lower overall scores.
However, because creditworthiness is largely determined by one’s ability to manage debt and make timely payments, a consumer will find their credit scores improving at a faster clip when they strive to maintain an excellent payment history. It is also wise to maintain low credit utilization ratios, as these ratios have the second-highest influence on a consumer’s credit score.
These are the five primary factors that impact one’s credit score –
■ The consumer’s payment history – approximately 35% of the scoring model.
■ The consumer’s level of debt & credit utilization ratios – – approximately 30% of the scoring model.
■ The age of the credit – approximately 15% of the scoring model.
■ The credit mix – approximately 10% of the scoring model.
■ New credit – approximately 10% of the scoring model.
What is the Lender’s Perspective on Foreclosure?
Although somewhat debatable, most lenders consider foreclosures among the most negative of credit blemishes, perhaps second only to someone declaring bankruptcy. Each lending institution sets forth its lending guidelines and criteria, which is why there is no universal rule that determines how lenders evaluate a foreclosure for lending purposes.
As a result, some mortgage lenders will not even consider a mortgage approval for mortgage applicants with a credit history that includes a foreclosure. In contrast, other lenders may choose to proactively disregard foreclosures that are several years old if the mortgage applicant meets all other qualifying criteria and has a strong credit profile with compensating factors.
Can a Foreclosure Entry on a Credit Report Be Removed?
Unfortunately, a foreclosure that has been legitimately reported to a credit repository cannot be removed from the report until it reaches its expiration date – seven years that start from the date of the borrower’s first missed monthly mortgage payment.
At the seven-year mark, the derogatory foreclosure entry should drop from the report automatically. If, for some reason, the foreclosure entry on a consumer’s credit report fails to drop from the profile, consumers can utilize a formal credit report dispute process regarding the erroneous reporting of an expired foreclosure record. When the foreclosure drops, the credit score should increase.
Foreclosures will likely impact one’s credit score, but a reduced credit score does not have to be a life sentence. In time, and with the implementation of good credit practices and choices, it is possible for consumers to raise their credit scores to acceptable limits that meet borrowing criteria.
A Word About Credit Scores & Loan Modifications
Loan modifications tend to impact one’s credit score negatively. However, the depth of the impact is contingent on the borrower’s other credit as well as how the lending institution chooses to report the modification to the credit bureaus.
If a lender reports the loan modification to the credit bureaus, with a status that reads ‘paid as agreed,’ the loan modification will have little to no impact on the borrower’s credit score. However, lenders may clarify the loan modification by reporting a status that reads – ‘paying through a partial payment agreement’ or ‘not paying as originally agreed.’
For example, under the Home Affordable Modification Program (HAMP, which was a federal program but is no longer active), lenders modifying an existing mortgage had the option to report the mortgage status as ‘not paying as agreed.’ Although not ideal, a credit report that notes ‘not paying as agreed’ is significantly better than the damage to one’s credit by bankruptcy, foreclosure, or a short sale.
Once a lender approves a permanent loan modification, the consumer’s credit score should improve due to on-time payments associated with the new agreement (i.e., loan modification) between the lender and the borrower. Note that previous delinquencies do not drop from the report until they reach the predetermined expiration date, although the depth and breadth of their impact tend to fade in time.
A Word About Tax Consequences to Consider When Facing Foreclosure
A foreclosure action results in the transfer of title, an event that triggers tax consequences. These tax consequences often come as a surprise to most homeowners and borrowers. According to the Internal Revenue Service, any time a debt is forgiven or canceled (that is, no longer required to be repaid), it is considered an event with tax implications.
A mortgage loan involves a borrower’s commitment to repay the funds borrowed in accordance with the mortgage loan terms. The mortgage proceeds are not considered taxable income by the IRS – when and if the borrower repays the money each month.
If the debt is forgiven (or somehow canceled), the borrowed funds are now considered income. This income becomes taxable because the borrower no longer has an obligation to repay the money owed. And note most losses incurred from foreclosure are not tax-deductible.
Need Help With Foreclosure Defense?
When facing mortgage delinquency, there are a number of loss mitigation options from which to choose. Remember, it is imperative to keep the lender apprised of your situation. Relaying the facts causing the financial difficulties is essential as this begins the process of a workout agreement, if available.
However, beyond that, it is wise to consult with an experienced foreclosure defense attorney who can help you weigh and balance the pros and cons of each of the loss mitigation legal solutions that may apply to your situation.