If you’re one of the millions who have lost a home to foreclosure, don’t lose heart. There’s still hope for your credit, and you may even be able to buy another home.

First, find out exactly what your credit score is saying about you, and what you can do to minimize the damage.

The bad news

According to Andrew Housser, co-CEO of Bills.com, a free consumer portal of personal finance information, it’s true that foreclosure can have a grim effect on your credit score. “A foreclosure will cause a credit score to drop sharply, typically by 200 to 300 points,” he says. “That would drop a score of 700 – considered a ‘good’ score – to as low as 400 – considered pretty terrible.” The minimum FICO score is 340.

Most lenders rely on credit bureau data, although they do not all use FICO scores. Some use their own scoring models, but those tend to have the same inputs, which include payment history, debt, new credit, and others. “Lower credit scores can result in being denied credit, such as credit cards and car loans, and facing much higher rates for loans and even other items, such as insurance, that rely on credit scores,” notes Housser.

The good news

But that’s not the end of the story. Though a foreclosure can remain on your credit report for seven years, it won’t ruin your credit score for life, adds Housser. “If you keep all of your other credit obligations in good standing, your FICO score can begin to rebound in as little as two years. The important thing to keep in mind is that a foreclosure is a single negative item. If you keep it isolated, it will be much less damaging to your FICO score than if you had a foreclosure in addition to defaulting on other credit obligations.”

Alan M. White, assistant professor at Valparaiso University School of Law in Indiana, would agree. “The impact of foreclosure on your score diminishes over time, depending on whether you have other active, on-time accounts,” he explains. “Even FHA [Federal Housing Administration] will allow a new mortgage to be approved if a past foreclosure was more than five years old,” he explains.

Alternatives to foreclosure

Of course, it’s preferable to avoid foreclosure altogether. Here are some ways to accomplish that goal. (Keep in mind, however, that many of these options require you to resume normal mortgage payments at some point. If you can’t afford to resume payments, it may not be worth the effort required to stop or reverse the foreclosure process.)

• Lender negotiation: If there is a reasonable expectation that you will be able to resume making regular mortgage payments within a relatively short time frame, the lender may be willing to work with you to establish a payment plan to bring the loan current. “Especially in today’s market, this is a greater possibility,” says Housser. “Many individuals are having trouble due to an unexpected job loss, medical expenses, divorce or other personal trauma. If the situation has some resolution so that the regular payments may be able to be met again, it is worth it to call the lender.”
• Forbearance agreement: For a temporary hardship, the lender might grant you a forbearance agreement to lower – or eliminate – payments for a limited time.
• Loan modification: This entails a permanent change to the loan, such as lowering the payment and extending the loan’s term or incorporating any delinquencies into future payments. “Lenders are more willing to discuss this now than they were before,” adds Housser.
• Deed-in-lieu of foreclosure: In this case, the lender takes ownership of the home, but that will not eliminate the negative impact of a payment delinquency or foreclosure that has already begun. “Bankruptcy remains on a credit report for 10 years, but it can offer a way to become current in payments, which will improve the credit score,” White notes.
• Refinancing: It may be possible to refinance a mortgage for a lower interest rate and/or monthly payment. But if you have already had late payments on a mortgage, the interest rate offered may be too high to lower your monthly payment. Housser recommends using online rate comparison sites and calculators to determine the “real costs of refinancing.”
• Short Sale: In a short sale, the lender accepts less than the mortgage debt when the property value has declined. “A short sale will prevent foreclosure,” says White. “However, if it takes place after foreclosure was initiated, the foreclosure and the related delinquency in payments will be reflected on the credit report.” The only way to protect the credit score fully is to maintain monthly payments until the house is sold.
• Chapter 13 bankruptcy: If the loan default is past the point of being resolved with the lender, you may file for chapter 13 bankruptcy protection. This protection requires you to resume making regular mortgage payments but allows the arrearage (being overdue in payment) to be repaid over the course of the chapter 13 plan.

All things considered, a foreclosure won’t ruin your credit rating forever. It will lower your credit score and remain on your credit report until you’re able to re-establish good credit, however, which takes time and careful planning. Consider your home purchase wisely.

– Writer Nina Silberstein contributed to this story.

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Tagged as: bad credit, Bankruptcy, Credit Bureau, credit report, credit score, FHA, FICO score, Foreclosure, Mortgage

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