How a foreclosure can impact your credit

You know that a foreclosure on your home can be a big deal when it comes to your credit. But how big of a deal can it be? You might be surprised at how much a foreclosure can impact your credit, and how long it can take to recover, depending on the situation.

Why foreclosure can be so devastating

Foreclosure can be so devastating because it is related to your payment history. Your payment history is the largest factor affecting your credit score. Before your home goes into foreclosure, there is a good chance that you have missed at least three payments. By the time the foreclosure process is complete, you might have missed even more payments. All of these missed payments are recorded in your credit history and affect your credit score.

The more payments you miss, and the more “important” those accounts are, the bigger the impact on your score. Additionally, CreditCards.com reports that your credit can be impacted even more if your credit score is excellent. If your score is 680 and you go through a foreclosure, you could see a drop of 85 to 105 points in your score. A higher score, of 780, could result in a drop of between 140 and 160 points.

Combining foreclosure with another problem, such as a short sale or a bankruptcy on your record, can be even more devastating and result in more difficulty as you attempt to recover your score.

Short sales and your credit

Elisabeth Ritter Kelly, the financial writer behind A Matter of Life or Debt, and her husband Michael found out the hard way that a near-foreclosure resulting in a short sale can be just as debilitating to a credit situation. They bought a home in 2007, just before the bottom fell out from the market. Even though the couple filed for bankruptcy in 2008, Kelly says the short sale process hurt them more.

They kept the house through the bankruptcy and started working to recover their financial situation. However, the market crash of 2008 meant that home values plummeted. Suddenly (and especially after putting in thousands for renovations), Kelly and her husband were stuck in a home that wasn’t worth what they were paying for it.

“After finding out we were expecting our third child, we realized that we’d never bounce back if we stayed in an underwater home,” Kelly says. “We started the short sale or foreclosure process.”

One of the problems with attempting a short sale is that many banks require that you show that you can’t get market value for your home and that you can’t keep making payments. As a result, many consumers stop making payments on their home loans when attempting a short sale. “Our bank required that we come close to foreclosure before we could be considered for a short sale,” says Kelly. The result was several missed payments, and a serious hit to Michael’s credit. “I was not in title on the house, so my credit wasn’t impacted the same way as my husband’s,” she continues.

Now, two years later, Michael Kelly’s credit score is still poor. “Even two years post short sale, his credit was stagnant at 550,” Kelly says. Without active measures to improve a credit situation, a foreclosure can continue to drag on your credit score, much as the short sale has dragged on the Kelly couple’s situation. Because a foreclosure can remain on your credit report for seven to 10 years, you need other, positive items to begin to make the delinquency less prominent.

In order to help her husband’s score, Kelly added him as an authorized user on one of her credit cards. “It boosted him to 600,” she says. While the strategy has helped, Michael’s credit score still needs some work. The two are looking for ways that they can continue to build up Michael’s score while also improving Elisabeth’s. “For now, I will have to be the primary borrower if we decide to borrow for something like a home or a car,” Kelly points out.

Improving your credit after a foreclosure

It can take several years to improve your credit after a foreclosure. You might not even be eligible to buy a home for two or three years after the foreclosure is complete. However, you can start working to improve your score.

One of the ways to get started is to have someone with better credit add you as an authorized user to a credit card account. However, for this strategy to be effective, you need to have a close relationship to the other consumer, as a spouse or a child.

You can also start improving your score by getting a secured credit card. You might not be able to qualify for a “regular” credit card right after a foreclosure, so a secured card can help you begin re-establishing your credit. As you make on-time payments, and they are reported to the credit bureaus, you can begin to see improvement. After nine months to a year, you should be able to “upgrade” to an unsecured card that will further help your score.

Other types of small loans, such as a personal loan from your bank or an auto loan, can also help you improve your credit. You need to be prepared to pay higher interest rates, though. As long as your credit is poor, you won’t qualify for the lowest rates. When your score starts to improve, you can take advantage of better offers and lower your interest rates.