Credit Impact of Short Sale, Foreclosure & Bankruptcy

Every consumer who is undergoing a short sale, foreclosure or bankruptcy worries about the future ability to obtain credit.   Lines of credit vary, but, for purposes of real estate discussion, the question I will pose on this article is:  “What are the guidelines for a home loan after a short sale, foreclosure or bankruptcy?”

FICO SCORE EXPLAINED

A FICO score is a number representing the credit worthiness of a consumer.  Established by Fair Isaac  Corporation in 1958,  the FICO score is the most used by lenders, though there are other credit scoring systems such as NexGen & VantageScore.  There are three credit reporting agencies namely: Experian, Transunion and Equifax -  at any given time, a consumer will have three different credit scores as these bureaus gather information from different creditors.  Credit agencies sell these information to the lenders, and a FICO score is the measure of a consumer’s probability to pay off a home loan.  The higher the credit score, the better.  

What’s in a FICO score?

Payment history, amounts owed, length of credit history, types of credit & the number of credit inquiries affect the overall FICO score of an individual.  The combination of all these, when factored in, are used by the scoring system to determine the risk of loaning to a consumer.   The following link breaks down the components that go into a FICO score, with payment history accounting for 35% on the overall scoreboard.

http://www.myfico.com/CreditEducation/WhatsInYourScore.aspx

BANKRUPTCY & FICO SCORE

Regardless of the type, bankruptcy has a very negative impact, for the whole time that it is showing on your credit report.  From the date of filing, one can expect to have this derogatory remark in the credit report, as follows:

1. Chapter 7 & 11- up to 10 years
2. Chapter 13 – up to 7 years

http://www.myfico.com/crediteducation/questions/Bankruptcy-Types.aspx

The impact of a bankruptcy filing depends on a consumer’s overall credit profile. Someone who has a high score and spotless credit should expect a huge drop in points. On the other hand, someone who has other negative items on the credit report will have only a modest drop in score.

Bankruptcy filing will usually include more than one account, like a credit card & an auto loan -  it should be noted that the more accounts filed in the BK, the more negative the impact is, on one’s credit.

Credit After a Bankruptcy

How long is the time period after a bankruptcy filing before a consumer can be eligible to obtain credit for a home loan?

Fannie Mae says:  for a Chapter 7 or 11 bankruptcy, is FOUR years from the discharge or dismissal date of the action.  For a Chapter 13 bankruptcy, it is TWO years from the discharge date and FOUR years from the dismissal date.

SHORT SALE, DEED-IN-LIEU, FORECLOSURE  & FICO SCORE

The impact on credit after a short sale or deed-in-lieu of foreclosure, is no better, from a credit score standpoint.  Though these foreclosure alternatives are tools being used by lenders to avoid the costly process of foreclosure, on the credit report, a short sale/DIL shows up as ‘ not paid as agreed,’ and is therefore, still derogatory.

http://www.myfico.com/CreditEducation/Questions/foreclosure-alternatives-fico-score.aspx

Credit After a Short Sale/ Deed-in-Lieu

How long is the time period after a short sale/preforeclosure has been completed before a consumer can be eligible to obtain credit for a home loan?

Fannie Mae says:  after TWO years from the date of completion of the preforeclosure sale, with consumer required to make a 20% downpayment ( or 80% loan to value); after FOUR years, the consumer is required to make a 10% downpayment ( or 90% loan to value); after SEVEN years, the consumer is limited to the loan to value ratios set forth in the Eligibility Matrix.

https://www.efanniemae.com/sf/refmaterials/eligibility/pdf/eligibilitymatrix.pdf

Deed-in-lieu, is another foreclosure alternative where a homeowner ‘deeds’ back title to the lender.  Under new HAFA guidelines, a DIL could be included as part of the short sale approval, only to be resorted to if the property does not sell within the time specified in the short sale.

For more information on the HAFA program, click here.

FORECLOSURE & FICO SCORE

Foreclosure hits one’s credit in the same way that bankruptcy does.  However, since foreclosure has only a single item defaulted on (home loan),  the impact is much less, compared to a bankruptcy.  Foreclosure remarks remain on the credit report for SEVEN years, but in as little as TWO years, FICO score begins to rebound, for as long as other obligations and loans are in good standing.

http://www.myfico.com/crediteducation/questions/Foreclosure-FICO-Score-Affect.aspx

Credit After a Foreclosure

How long is the time period from the date of foreclosure can a consumer can be eligible to obtain credit for a home loan?

Fannie Mae says:  after SEVEN years from the date of the foreclosure sale was completed, except, under extenuating circumstances, a consumer can apply for a home loan after THREE years from the foreclosure sale date.

• Extenuating circumstances refer to non-recurring events that has led to the consumer to default on the mortgage, such as, divorce, medical / hospitalization, job loss, death in the family, etc. Proper documentation is required to qualify the consumer obtaining a home loan after a foreclosure.

Note however, that lending guidelines for other types of loans such as FHA, VA are different from conventional financing.

Life doesn’t stop after a short sale, foreclosure or bankruptcy.   Planning and keeping a good credit standing after these events will definitely pay off. A second chance at homeownership is not at all impossible!