Foreclosure and Credit Score

Foreclosure and Credit Score

Table of contents

A home foreclosure can reduce your credit score and affect your ability to qualify for new loans, including a new mortgage. How does a foreclosure affect your credit score? How long does a foreclosure stay on your credit? Are there things you can do to avoid foreclosure?

Key takeaways

  • Foreclosure is when a borrower doesn’t pay their mortgage, and the lender takes ownership of the property.
  • Foreclosure hurts your credit score and stays on your credit report for seven years after the first missed payment.
  • Foreclosure entries are viewed negatively by lenders and can hurt your chances of getting approved for loans.
  • To avoid foreclosure, contact your lender right away, ask about forbearance or loan modification, seek advice from a HUD-certified counselor, consider selling your home, or talk to your lender about a short sale option.
  • Foreclosure has tax consequences, including reporting canceled debt as income and calculating capital gains from the foreclosure.

What is a foreclosure?

When you have a mortgage on a property, the mortgage is actually a lien on the property. When a borrower fails to meet the obligations of the mortgage, they enter default. While this typically means missed mortgage payments, it can also include the failure to maintain mortgage insurance or maintain the upkeep of the property. Foreclosure is the process that occurs when a lender takes ownership of the property after the borrower enters default.

The foreclosure process has multiple stages that include:

  • Payment default: While a foreclosure can begin as soon as the first missed mortgage payment, default typically does not occur until after several payments are missed.
  • Notice of default: After 90 days (this timeframe can vary by lender), a Notice of Default is sent to the borrower offering a potential resolution to avoid foreclosure. This stage is considered pre-foreclosure.
  • The lender takes possession: If the borrower is unable to make suitable arrangements to rectify the default, the lender takes possession of the property.
  • Notice of trustee’s sale: The lender is required to record and publish an impending sale with the county and publish the notice in local newspapers.
  • Trustee’s sale: The home is listed and placed for sale through public auction.
  • Transfer of ownership to the lender: If the home does not sell at auction, the ownership of the property transfers to the lender.

How does a foreclosure affect your credit?

A foreclosure appears on your credit report within a month or so after the initial foreclosure proceedings begin. While a foreclosure does have a considerable impact on your credit score, the months before foreclosure are likely to cause a greater impact. To reach the foreclosure process, the borrower typically misses at least 3 to 4 monthly payments. Missed payments account for the biggest drop in a borrower’s credit score, so by the time the foreclosure hits your account, the damage is already done.

How long does foreclosure affect your credit?

As mentioned above, a foreclosure appears on your credit report within a month or two of the foreclosure proceedings. This foreclosure entry remains on your credit report for seven years from the time of your first missed monthly payment.

How do lenders see a foreclosure?

While lenders typically look at your overall credit score, a foreclosure entry is often viewed negatively, second only to bankruptcy. A foreclosure entry will keep you from approval by many lenders, despite meeting their credit score requirements and other lending criteria.

What are the tax consequences of a foreclosure?

When it comes to taxes, a foreclosure is treated the same way as the sale of a property. A foreclosure often means the cancellation of your outstanding debt. You are obligated to report this debt cancellation as ordinary income in Box 2 of a 1099-C form that you receive from the lender when this occurs. You are also required to calculate the capital gain from the foreclosure.

Ways to avoid foreclosure

Unfortunately, life can throw curveballs, making it difficult to make monthly obligations, such as your mortgage payment. Missing multiple payments will lead to a foreclosure if simply ignored. However, there are things you can do to help avoid foreclosure and protect your credit score.

1. Contact your lender immediately

If you have experienced a temporary setback, such as a loss of employment, contact your mortgage company immediately to let them know what the situation is. Your lender may be willing to work out a repayment plan that allows you to catch up on missed payments by adding a portion of them to your regular monthly payments. Maintaining regular contact with your mortgage lender will show that you are committed to taking care of your obligations. In some cases, your lenders may also offer one of the additional options below.

2. Request a forbearance

If you are experiencing temporary financial struggles, you may be able to request a mortgage forbearance from your lender. This forbearance places a temporary hold o your mortgage payments for a specified time period. However, at the end of it, you are required to pay the full amount accrued during the forbearance period or commit to a repayment plan established by your lender.

3. Consider a loan modification

A loan modification works similar to a loan refinance and can help to make your current monthly payments more manageable. In many cases, this modification occurs by extending your loan term, allowing for a reduction in monthly payments. Ask your lender if a loan modification is an option.

4. Seek advice from a HUD-certified counselor

If you are feeling overwhelmed, the Department of Housing and Urban Development (HUD) offers housing counseling throughout the country. Their services are typically provided at little to no cost, and they can help walk you through trying to halt the foreclosure process and save both your property and credit.

5. List your home for sale

If you are unable to afford your monthly mortgage payments, putting your home up for sale may end up being your best option. In a strong housing market, you can often sell your home before the foreclosure process starts, allowing you to avoid foreclosure.

6. Talk with your lender about a short sale

If you do not have any luck traditionally selling your home, you can talk with your lender about a short sale option. A short sale means you sell the home for less than the amount you owe. The sale proceeds go directly to the lender, and the lender is willing to forgive the remaining balance. Before you can consider this option, you will need to receive approval from your lender and, when given approval, include the fact that this is a short sale pending approval on all your sale listings.

7. Request a deed in lieu of foreclosure

If you cannot work out payment arrangements or sell your home in time, you can request a deed in lieu of foreclosure. With this, you transfer ownership of the home directly to the lender in exchange for a release from your mortgage obligation. This avoids a negative foreclosure report to your credit and releases you from your payment obligations.

Can you remove a foreclosure from your credit report?

As long as a foreclosure is legitimate, it cannot be removed from your credit report until the 7-year period expires. The best way to avoid a foreclosure on your credit report is to follow the tips listed above.

A foreclosure doesn’t keep you from owning a home.

While losing a home can be devastating to you and your credit, it will not keep you from owning a home again in the future. In fact, it is often possible to qualify for a new mortgage within 2-3 years after a foreclosure. At Hero Home Programs, we understand that life happens. Our goal is to help individuals and families achieve the dream of homeownership and, despite a foreclosure, we can often help. To learn more about our services, contact us online today.

Jacquelyn Sublett
Jacquelyn Sublett

I love teaching and writing on real estate, finance and mortgage topics. I find it fulfilling hearing stories of first time home buyers who we have helped with the home buying process. Writer for the Hero Homebuyer Programs™

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