How Foreclosure, Deed in Lieu, and Short Sale Affect Credit Scores

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Currently millions of Americans are delinquent on their home loans or facing foreclosure. Foreclosure, deed in lieu of foreclosure, and short sales are several ways for borrowers to get out of a mortgage that is no longer affordable. Here is a quick guide to what these options are, and how much they could affect one's credit score.

Foreclosure

A foreclosure happens when a borrower has defaulted on a property and the lender claims ownership of the property. Usually lenders start the foreclosure process after three missed payments. The property would then be sold at a public auction. The impact of the foreclosure to a borrower's FICO score is around 200 to 300 points if you include the effects of the missed payments. A foreclosure stays on your credit report for seven years.

Deed in Lieu

A deed in lieu of foreclosure is where the borrower gives the deed back to the lender with the lender's approval. The lender also forgives the remaining balance on the loan. The borrower still loses the home. It depends on how the lender reports this to your credit report but the credit drop could be as large as a real foreclosure and the record would stay for seven years. If your lender does accept a Deed in Lieu then you could try to negotiate with them to not put a foreclosure notification in your credit record, but if you had late payments your credit would still be affected.

Short Sale

This is not exactly a foreclosure, but a deal with the lender to sell a home for less than what is owed. Basically the borrower has to find a buyer who is willing to purchase the home at a price approved by the bank. The credit impact depends on how many late payments there are. If a short sale is completed without any late payments then the credit impact would be much less than that of a foreclosure. If the borrower accrues a significant amount of late payments during the short sale then the credit impact could still be as much as 200 points.

If you have to default on your mortgage, just remember that losing a home is not the end of the world and credit can be rebuilt. It generally takes two to three years for someone who went through one of the above events to qualify for another home loan. If a borrower keeps payments current on obligations other than the mortgage then the foreclosure would be an isolated negative event and that would not be indicative of a history of bad credit. This is why those who strategically walk away from their homes keep current on their credit cards and other loans because they can get back their "prime" credit score fairly quickly.

Have you gone through one of these events? How did it affect your credit score?