A foreclosure can mar your credit report for seven years from the date of your first missed payment. During that time, it can affect your credit score and the way other lenders view your creditworthiness in the future.
If you're struggling with your mortgage payments, it's important to understand the foreclosure process, steps you can take to avoid it and what you can do to recover if it happens.
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What Leads to Foreclosure?
Foreclosure happens when you fall far enough behind on mortgage payments that the lender repossesses your home to satisfy what you owe.
In general, the legal foreclosure process can't begin until after you've been late on your mortgage for 120 days. After that, the time it takes to complete the process can vary, depending on the company servicing your loan and where you live.
"Foreclosure is usually a lender's last resort after a consumer hasn't made their loan payments," says Amy Thomann, head of consumer credit education at TransUnion.
The actual process and foreclosure laws can differ by state, but in general, a mortgage lender may have two options:
-- Judicial foreclosure. With this type, the lender must file a civil lawsuit in court, allowing the borrower to defend him or herself.
-- Nonjudicial foreclosure. This option allows lenders to foreclose without court involvement, instead following steps written out in a power of sale clause in the mortgage contract or deed of trust.
The mortgage lender is required to notify you about the proceedings, so it won't come as a surprise. But if you're struggling to keep up with your payments, it's best to address the situation before it comes to that point.
How a Foreclosure Can Hurt Your Credit
Once it hits, a foreclosure will remain on your credit report for seven years from the date of your first missed payment. After that, it'll automatically be removed from your report.
It's impossible to say exactly how many points a foreclosure can knock off your credit score because several other factors are considered when calculating the three-digit number.
That said, your payment history is the most important factor in your FICO credit score, making up 35% of its calculation.
Foreclosure "is the last and most serious step after a series of missed payments," says Thomann, "so it will likely have a large negative effect on your credit score."
What's more, you'll also feel the sting of the missed payments that led up to the foreclosure, which will compound the negative effect.
As a result, a foreclosure can make it difficult to get approved for credit in the future. It won't, however, completely eliminate the possibility altogether. There are subprime loans available to people who have negative items on their credit report. Just keep in mind that interest rates on these loans are typically very high, increasing your monthly payments and total interest charges.
Also, there is a minimum waiting period after foreclosure for most types of mortgages:
-- Conventional home loan: Seven years
-- U.S. Department of Agriculture or Federal Housing Administration loan: Three years
-- Department of Veterans Affairs loan: Two years
If you can prove that the foreclosure was the result of a qualifying hardship, such as unemployment or medical bills, the waiting period may be shortened to three years for conventional loans and one year for USDA and FHA loans. Either way, it may be a while before you'll have the opportunity to become a homeowner again.
Note that it's possible to avoid foreclosure by performing a short sale, which allows you to sell your home for less than what you owe, or a deed in lieu of foreclosure, where you voluntarily turn over the property to the lender. While these options will keep a foreclosure off your credit report and may shorten waiting periods before you can get a new mortgage, don't expect to save your credit by choosing them.
"There is no difference on the impact to a credit score, as they all represent a default on the loan," says Thomann.
How to Prevent Foreclosure Damage
Credit damage from a foreclosure starts with your first missed payment. If you're having a hard time staying current on your mortgage, it's important to act early to try to get ahead of the problem.
As soon as you think you're going to have trouble making a payment, reach out to the lender. "In some cases, the lender proactively reaches out to borrowers to check in with you and see what's going on," says Leo Loomie, senior vice president at Digital Risk, a company that provides risk, compliance and technology services to mortgage lenders.
Whether you call or your lender calls you, explain why you'll be unable to make the payment, outline your income and expenses, and estimate how long you think the issue will last.
Because it's in the lender's best interest to help you maintain the loan, you may be able to temporarily reduce or suspend payments with forbearance or refinance to a more affordable payment with loan modification.
"There are a lot of different ways you can look at potentially modifying the terms to work in favor of the borrower and get them back on their feet," says Loomie. A forbearance or other workout plan may help you protect your credit rating by making it possible for you to avoid missed payments and the damage of foreclosure.
It's also a good idea to speak with an approved housing counselor who can potentially help you avoid foreclosure and identify special assistance programs you may qualify for. Of course, watch out for scams and avoid companies that promise to save your home for a fee or make guarantees that don't sound realistic.
Recovering from a Foreclosure
If you're unable to stop foreclosure from happening, it and the delinquent payments can drop your score immediately.
Fortunately, though, the FICO score favors new information over old, so while a foreclosure will stay on your credit report for seven years, it is possible to reduce its negative effects over time with positive credit behaviors. Here are some ways you can rehabilitate your credit score over time:
Take a look at your finances. Foreclosure doesn't always occur because of financial irresponsibility. If you've lost your job or incurred crippling medical debt, it can be hard to find a way out.
But if you have made some mistakes along the way, evaluate your financial situation holistically, says Loomie. "Look at your expenses and areas where you can sacrifice to get back on track with your money," he adds.
[Read: Best Mortgage Lenders.]
Address other negative credit report items. If you have other accounts that are delinquent or in collections, get caught up as quickly as possible. Also, check your credit report to make sure all the information is accurate.
If you find an entry that's inaccurate, you can file a dispute with the credit reporting agencies to have it removed, potentially helping your credit score.
Make on-time payments. Again, your payment history is the most important factor in your FICO score, so making your other debt payments on time is critical to your success.
Whether it's credit cards, an auto loan or student loans, set up automatic payments and prioritize those monthly payments to create a positive payment history going forward.
Reduce your credit card balances. If you have credit cards, limiting your balance each month can help improve your credit score. While some experts recommend keeping your credit utilization -- your balance divided by your credit limit -- at or below 30%, the lower it is, the better.
If you don't carry a balance each month, you can lower your credit utilization by making multiple payments throughout the month or finding out when your card issuer reports your payments and making a payment a couple days before.
If you have a large balance that you can't afford to pay off right now, consider using a balance transfer credit card to eliminate interest from the equation for a while. Alternatively, you can use a debt consolidation loan, which will reduce the card balance and your utilization to zero.
Avoid unnecessary debt. While taking on new debt doesn't directly impact your credit score in a major way, it can make it difficult to keep up with your other debt payments. If this happens, you could end up right back where you started with missed payments and dings to your credit score.
If you're considering opening a credit card or taking out a loan, carefully consider all your alternatives and whether you can get what you need another way.
Be patient. A foreclosure is a major credit event, so don't expect to see a full recovery overnight. With effort and patience, though, you can see positive and lasting improvements. "It takes time to rebuild your credit, and the negative impact a foreclosure will have on your credit score generally will decrease over time," says Thomann.
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