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Your Credit Score After Foreclosure

Your Credit Score

Our credit score has become an important number in our lives. Increasingly, credit scores are being used for purposes beyond determining whether you will make late payments or default on a loan. Our credit score is used to determine whether we can qualify for a loan, with a reasonable interest rate for such large ticket items as an automobile or home. Insurance companies, mobile phone companies, utility companies, employers, and landlords use our credit scores to determine our eligibility and a poor credit score could disqualify you from a government security clearance. Low scores can cost consumers thousands of dollars a year in additional finance charges, higher rent, insurance rates, and could cost you your dream job.

For people who pay their bills on time and don’t over-extend themselves financially, worrying about their credit score is not an ongoing concern. In fact, most Americans will not experience a large change in their credit scores over time. Only about 25% will experience an event in their lives that will impact their credit rating by more than 20 points in a three-year period. Even if you are a responsible credit consumer and pay your bills on time and don’t over-extend yourself financially, it is important to understand your credit score and monitor and maintain it diligently. According to CFA Executive Director Stephen Brobeck “Lack of consumer knowledge about credit scores no only increases the costs of their credit and insurance but also reduces the availability of these and other services.” In a recent survey commissioned by the Consumer Federation of America (CFA), and Washington Mutual Bank (WaMu) less than one-third or 31% of Americans understand that credit scores indicate the risk of nonpayment. It is important to educate yourself about credit scores. Use of the knowledge could result in sizable savings for borrowers. Unfortunately, some events such as judgments, liens, bankruptcies and foreclosures, can have a dramatic effect on your credit score.

What Affects Your Credit Score

With so much riding on the health of our credit score, many are motivated to understand exactly how these scores are calculated. Unfortunately, the exact mathematical formula used to calculate credit scores is a trade secret. We do know the factors credit reporting agencies use to determine our credit score and approximately how much weight each has on the overall score. The factors used and the weight each has on our credit scores are:

Payment history accounts for approximately 35% of our credit score.
Approximately 30% of our score is determined by how much we owe.
How long we’ve had credit accounts for approximately 15% of our score.
Approximately 10% is applied to time lapse since our most recent credit application.
The type of credit (installment, revolving or both) we use accounts for 10%.

These are, of course generalizations. You’ll find that each is often weighted differently from credit agency to credit agency and lender to lender, but the same combination of factors is used to calculate credit scores. Furthermore, we know that events such as bankruptcies, liens, judgments, and foreclosures can have a devastating affect on our credit rating and are collectively viewed negatively by credit agencies, lenders, and other institutions.

Foreclosure Impact On Your Credit

According to a report by the Mortgage Bankers Association (MBA), nearly one in ten homeowners faced foreclosure or fell behind in their payments during the first quarter of 2008. As more Americans are affected by foreclosure many are becoming concerned about the long-term impact a foreclosure may have on their credit. What impact does a foreclosure have on a credit score?

A foreclosure will continue to show on a credit report for several years. Federal law dictates that negative items such as foreclosures and defaults are generally only removed after 7 years.
A foreclosure impacts the overall health of your credit score. The point impact a foreclosure has on an individuals credit report is estimated to be from 125 to 175 points. Late payments on your mortgage as well as other bills will also decrease your credit score. If you calculate the net effect of both of these factors your credit score could decrease about 240 to 260 points.
The impact a foreclosure has on your credit makes it virtually impossible for you to be extended credit at a low interest rate. Borrowers who have a foreclosure on their credit report will have to pay a higher interest rate, approximately 1 ½ to 2%, unless you are able to come up with a down payment of 10% to 20% of the purchase price.
It usually takes about 2 years to raise your credit scores back to what they need to be to qualify for a prime conventional mortgage. For at least 2 years you will not be eligible for a prime conventional mortgage from Fannie Mae or Freddie Mac. In short, you typically have to have outstanding credit for a minimum of 2 to 3 years before many creditors will feel comfortable with giving you a prime conventional loan at a reasonable interest rate.

Despite the claims of “credit repair experts”, there is no easy way to improve your credit score or remove a foreclosure from your credit history before 7 years. Only time and maintenance will repair your credit score and remove the blemish of foreclosure from your credit history.

So, how do you rebuild your credit after foreclosure?

Pay all of your bills on time. This is very important for getting your credit scores back on track.
Keep your credit balances low. Keep your balances under 10% of the limit on the card. You can go over the 10% limit, just make sure you pay it off as soon as possible.
Pay off your credit cards rather than moving debt between them.
Write a detailed explanation about the circumstances surrounding your foreclosure. You are allowed to write a statement that will become a permanent part of your credit report. This statement will have to be submitted to each credit bureau. This will not help your score but might help your credibility with potential future lenders.
Check your credit report regularly.
Don’t cancel old credit cards and only apply for new ones when needed.

If you successfully rebuild and consistently maintain a strong credit history, you will find that a foreclosure will have less impact on your credit over time.