How Foreclosure, Short Sale, Bankruptcy, and Loan Modification Affect Your Credit Score

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 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.

FICO and VantageScore are the two most widely used scoring models in the U.S. Both help lenders assess how likely someone is to repay borrowed money, such as a mortgage loan.

How FICO Credit Scores Work

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 hurt your scores. Also, carrying a balance on several accounts 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.

What Factors Does VantageScore Use?

The VantageScore model uses comparable factors to FICO and weighs them similarly. But there are slight differences. Here's how VantageScore 4.0 generally weighs credit factors:

• Payment history (41%). Whether you pay your bills on time has the biggest impact on your score.
• Age and type of credit (20%). According to the VantageScore website, it's helpful to have older accounts and a variety of accounts (such as credit cards, auto loan, mortgage, etc.) over time to improve your score.
• Credit utilization (20%). VantageScore considers how much credit you have and how much you're using. In general, it's best to reduce the total amount you owe to improve your score. You should probably focus on keeping your revolving balances low (under 30% of available credit limits but above 0%).
• Recent credit behavior and inquiries (11%). Opening many new accounts in a short period will negatively affect your score, though not as much as some of the other factors.
• Balances (6%). High balances on your accounts can hurt your score even if you're current on your payments.
• Available credit (2%). Having a larger amount of credit available can raise your score slightly.

What Happens to Your Credit After a Foreclosure or Alternative

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 the worst. Here's a summary of how a foreclosure or foreclosure alternative affects your credit, with more details below.

How Does a Foreclosure Affect Your Credit Scores?

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 among the few people with 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 won't matter as much (because your credit is already damaged).

How Long Do Negative Marks Stay on Your Credit Report?

How Does a Short Sale Affect Your Credit Scores?

If you're one of the rare homeowners who haven't missed a payment before doing 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. (Same goes for a deed in lieu of foreclosure.)

But, overall, there isn't a huge difference between foreclosure, short sale, and deed in lieu of foreclosure when it comes to how much your scores will drop.

Loan Modifications: Credit Score Consequences and What Lenders Report

The impact of a loan modification on your credit might be negative. But it depends on your other credit and how the lender reports it. If your lender reports the modification as "paid as agreed," the modification won't affect your credit score much. If not, damage can be similar to other negative events.

How Lenders Report Modifications to the Credit Bureaus

Sometimes, the lender will report a 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 scores, although it's not likely to be as negative as a short sale, foreclosure, or bankruptcy. But if the lender reports the account as "paid as agreed," there might be minimal impact to your credit scores.

After You Get a Modification, Your Credit Scores Should Go Up

According to the American Bankers Association, once a permanent modification is in place, your scores 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.

Bankruptcy and Credit Scores

Bankruptcy typically drops a credit score by around 130 to 240 points. But even though filing for bankruptcy immediately lowers your credit score, the impact could be less than you might think. If you already have many negative items already listed on your credit reports, you can expect to experience less of a drop in your score. But the more accounts included in the bankruptcy filing, the more significant the impact.

Oddly enough, filing for bankruptcy can help you build good credit sooner than if you don't file for bankruptcy and continue to struggle with more debt than you can handle, especially if you wind up filing bankruptcy later anyway. Eliminating or reducing debts through bankruptcy will help you meet the two most important goals for a good credit score: making your payments on time and not using most of your available credit .

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 other option 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. That's 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, 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 largely on how far behind in payments you were before you lost your home to a foreclosure, gave it up in a short sale, completed a loan modification, or filed for bankruptcy. Most people who resort to these options have already fallen behind on mortgage payments.

How Missed Mortgage Payments Affect Your Credit Scores

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 90+ days late. 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 the 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 longer to claw your way back to your original scores if they started out high.

Steps to Rebuild Your Credit

However, the time it takes to rebuild credit is mainly affected 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.

Learn More About Credit Issues

To learn more about credit scores and cleaning up your credit, get Nolo's Credit Repair: Make a Plan, Improve Your Credit, Avoid Scams by Attorneys Amy Loftsgordon and Cara O'Neill.