Which Is Worse for Your FICO Score: Bankruptcy, Foreclosure, Short Sale, or Loan Modification?

Foreclosure and its alternatives will cause your credit scores to drop—the amount depends on your credit history and other factors.

If you're struggling to make your mortgage payments, seriously behind in them, or already facing foreclosure, you might be wondering about the impact of a foreclosure or foreclosure alternatives on your credit. The truth is, whether you file for bankruptcy, let your home go through foreclosure, complete a short sale, or even work out a loan modification with the bank, your credit scores will probably suffer.

But will one of these options impact your credit scores more than another? Foreclosures, short sales, and bankruptcy are all bad for your credit. Bankruptcy is the worst of the bunch. A loan modification might not be so bad, depending on how the lender reports the modification to the credit bureaus.

How FICO Credit Scores Work

A "credit score" is a number assigned to you by a credit scoring company that predicts the likelihood that you'll default on your payment obligations. Credit scoring companies use different factors and calculations to come up with your scores (you have more than one), but for the most part, the information they use is contained in your credit reports.

    Many credit scoring companies exist, but FICO scores are used in 90% of all mortgage loan applications (according to FICO). Factors influencing your FICO scores include:

    • Payment history (35%). Your scores are negatively affected if you've paid bills late, had an account sent to collection, or declared bankruptcy—the more recent the problem, the lower your scores.
    • Outstanding debt (30%). FICO considers the amount of debt you have compared to the amount of credit available to you; if the amount you owe is close to your credit limit, that's likely to have a negative effect on your scores. Also, if you carry a balance on a number of accounts, that might lower your scores because it looks like you're overextended.
    • Length of your credit history (15%). The longer your accounts have been open, the better.
    • New credit (10%). If you've recently applied for many new accounts, that might negatively affect your scores. Promotional inquiries don't count, though.
    • Types of credit in use (10%). FICO says it's looking for a "healthy mix" of different types of credit, both revolving and installment accounts.

    FICO scores range from 300 to 850. Higher is better.

    How a Foreclosure, Bankruptcy, or Short Sale Affects Your Credit Scores

    A foreclosure or short sale, as well as a deed in lieu of foreclosure, are all pretty similar when it comes to impacting your credit. They're all bad. But bankruptcy is worse.

    Going through a foreclosure tends to lower your scores by at least 100 points or so. How much your scores will fall will depend to a large degree on your scores before the foreclosure. If you're one of the few people who had higher credit scores before foreclosure, you'll lose more points than someone with low credit scores. For instance, according to FICO, someone with a credit score of 680 before foreclosure will lose 85 to 105 points, but someone with a credit score of 780 before foreclosure will lose 140 to 160 points. According to experts, late payments cause a huge dip in your credit scores, which means a subsequent foreclosure will not matter as much (your credit is already damaged).

    If you're one of the rare homeowners who haven't missed a payment before doing, say, a short sale, that event will cause more damage to your credit. And if you avoid owing a deficiency with a short sale, your credit scores might not take as big of a hit. But, overall, there isn't a huge difference between foreclosure and a short sale when it comes to how much your scores will drop.

    How a Loan Modification Affects Your Credit Scores

    The impact of a loan modification on your credit will probably be negative, but it depends on your other credit and on how the lender reports it. If your lender reports the modification as "paid as agreed," the modification won't affect your FICO score. Unfortunately, the lender is likely to report the modification as "paying under a partial payment agreement" or something else indicating you are "not paying as agreed." For example, in the past, many loans were previously modified under HAMP (the Home Affordable Modification Program—a government modification program that's no longer available), which allowed negative reporting during a trial modification. Any "not paying as agreed" report will negatively impact your credit score—although it's not likely to be as negative as a short sale, foreclosure, or bankruptcy.

    According to the American Bankers Association, once a permanent modification is in place, your score should improve because timely payments will appear as paid in accordance with the new agreement. But the past delinquency won't be removed from your credit reports.

    Why Is It Hard to Say Exactly How Far Your Scores Might Drop?

    According to FICO statistics, on average, a bankruptcy is worse for your credit than any of the other options discussed in this article. But it's difficult to guess exactly how much damage a bankruptcy, foreclosure, short sale, or loan modification will do to your credit because:

    • Credit scoring systems change over time.
    • Credit scoring agencies don't make their formulas public, and your score will vary based on your prior and future credit practices and those of others with whom you are compared.
    • Creditors use different criteria in evaluating consumers for credit, and these also change over time.
    • Market conditions and the economy affect creditors' willingness to offer credit, so even what was true a year or so ago might not be true now.

    But it also depends, in large part, on how far behind in payments you were before you lose your home to a foreclosure, give it up in a short sale, complete a loan modification, or file for bankruptcy. Most people who resort to these options have already fallen behind on mortgage payments. When you stop making your mortgage payments, the servicer (on behalf of the lender) will report your delinquency to the credit reporting agencies as 30 days late, 60 days late, 90 days late, and so forth. The agencies then list the delinquencies on your credit report. FICO says your score will drop around 50 to 100 points when the creditor reports you as 30 days overdue. Each reported delinquency hurts your credit score even further.

    Again, in general, if your scores are high to begin with, each of options discussed in this article will cause a deeper dip in your scores than if your scores started out on the low side. It will also likely take you longer to claw your way back to your original scores if they started out high. However, the time it takes to rebuild credit is affected largely by your payment history and outstanding debt going forward. If you have excellent payment behavior (that is, you make all payments on time), and your available credit increases, your scores will improve more quickly than if you continue to make late payments and remain overextended.

    Getting Help

    Credit scores are only one factor to consider if you're thinking about filing for bankruptcy, completing a loan modification, or letting your home go in a foreclosure or short sale. If you need help balancing the pros and cons of different loss mitigation options (or letting a foreclosure happen), consider talking to a bankruptcy attorney or a foreclosure attorney. If you need general information about alternatives to foreclosure, consider talking to a HUD-approved housing counselor.

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