If you stop making payments on your mortgage loan, you’ll probably go through a foreclosure, which will damage your credit score. Even if you manage to avoid going through a foreclosure with a short sale or a deed in lieu of foreclosure, your credit score will take a major hit.
Read on to learn the basics about why credit scores matter, how they work, and how a foreclosure, short sale, or deed in lieu of foreclosure typically hurts your credit score.
If you apply for home loan or other form of credit, like a credit card or a car loan, the creditor will take a look at your credit score from one or more of three major credit reporting agencies—Equifax, Experian, and TransUnion—as part of the process of figuring out whether or not to extend you the credit. Credit scores, in theory, indicate whether you’re likely to default on the loan. Generally, people with lower credit scores are more likely to default on payments than people with higher scores.
Your credit score is based on what’s in your credit report, including:
Credit scoring companies use “models” that analyze this data and then assign a credit score based on that information. Different companies use different scoring models so a person’s credit score usually varies by a few or many points depending on which company and model generated the score.
Typically, credit scores—like scores from the largest and most universal credit scoring company called FICO—range from 300 to 850. VantageScore, which is another credit scoring company, also uses a range of 300 to 850 in its newer model, while its older models have a range of 501 to 990.
Both missed mortgage payments and a foreclosure itself will damage your credit score.
How missed (or late) payments affect your score. Under federal mortgage servicing rules, in most cases, a borrower has to be more than 120 days delinquent on payments before the servicer can officially start a foreclosure. The lender reports the missed payments as 30 days late, 60 days late, 90 days late, and the like to the credit reporting agencies. According to FICO, a person’s credit score drops about 50 to 100 points when the lender reports the account as 30 days past due and each subsequent delinquency lowers the score further.
How foreclosure affects your score. After a foreclosure, your score will likely go down by at least 100 points. How much the score actually falls depends to some extend on your score before the foreclosure started. Someone with a higher score prior to a foreclosure generally loses more points than someone who already has a low score. According to FICO, a person who has a credit score of 680 prior to a foreclosure loses 85 to 105 points following a foreclosure. But a person who has a credit score of 780 prior to a foreclosure loses 140 to 160 points.
Completing an alternative to foreclosure, like a short sale or deed in lieu of foreclosure (DIL), will also usually hurt your credit score.
Generally, short sales and DILs have a similar effect on a person’s credit score. Much like with a foreclosure, if you have high credit score before the short sale or DIL—say you complete one of these transactions before missing a mortgage payment—the transaction will cause more damage to your credit score. Though, if you’re behind on your payments and already have a low score, a short sale or DIL won’t cause you to lose as many points as someone who has a high score.
Also, if you’re able to avoid owing a deficiency after the short sale or deed in lieu of foreclosure, your credit score might not fall quite as much.
Scammer credit repair companies sometimes try to sell their services claiming that they can easily repair your credit score or even clear a foreclosure off your credit report. However, foreclosures and many other negative items typically stay on a credit report for seven years and you can’t magically eliminate them—though the impact of these events on your score will lessen over time. Also, paying your other debts on time and disputing incomplete and inaccurate information in your credit report can improve your score.
If you want more information about how to improve your credit score, consider talking to a credit repair attorney. If you have questions about ways to avoid a foreclosure, consider talking to a foreclosure attorney or a HUD-approved housing counselor.