Bankruptcy, Foreclosure and Short Sales Damage Your Credit

 

If you are contemplating foreclosure or bankruptcy, your

credit score may be the last thing you should consider, says

Rod Griffin, director of public education for credit reporting

agency Experian.

 

“Should you really be worrying about your credit score?  Because 

if you are worried about your credit score you are planning to

borrow,” Griffin says.  Your emphasis should be on stabilizing

your finances, he said. And if your cash situation is unstable,

you probably shouldn’t be borrowing.

 

Still, if you can no longer afford your mortgage or pay your bills, it may be useful to know how each of your financial options will affect that credit score. 

 

“It’s one of those issues where it’s kind of degrees of bad,” says Rod Griffin, director of public education for credit reporting agency Experian.

 

Whatever you decide to do, the more debt your action encompasses and the more it damages the lender, the more effect it will have on your credit score.

 

Griffin lines them up this way, from least bad to worst:

 

-  Deed in lieu of foreclosure

 

-  Short sale

 

-  Foreclosure

 

-  Bankruptcy

 

“Bankruptcy involves all of your debts so it compounds the issue,” he says.

 

Any of these black marks will age off your credit report after a period of time, and the amount of time it takes for them to disappear and the date on which the counting begins are set by federal law.

 

“With negative information on a credit report, the date begins on the original delinquency date, which is the first date you missed a payment,” Griffin says.

 

With defaults or settlements showing on your credit history, Griffin said, you will have trouble obtaining further credit and likely will pay higher interest or fees on any credit you are able to secure.

 

 “A mortgage has a tremendous impact on credit reports and credit scores,” Griffin says. It is the largest debt most people will ever have, and it is usually the last thing they default on – which means they may already have a damaged credit history by the time they dump the house.

 

 

In a deed in lieu of foreclosure, a homeowner turns over the keys and gives up in the house in exchange for forgiveness of the mortgage. It is an arranged deal with the lender.

 

The exchange will be reported as a settlement on your credit history. A settlement occurs when an account is closed without

the terms of the loan agreement having been met.

 

“Any time you settle a debt, it is considered negative,” Griffin says.

 

Settlements stay on your credit report for seven years.

 

 

Short sales are misunderstood, Griffin says. They are getting a reputation for being a way to get out of your mortgage with few consequences, he says. But, In fact, they are a form of settlement.

 

The term “short sale” will never show up on your credit report, Griffin said. Instead the mortgage will be reported as settled, indicating the terms of the original loan were not met but the account is closed.

 

A short sale will remain on your credit report for seven years.

 

 

A foreclosure occurs when you fail to make principle and interest payments and the lender – whether it is a bank, credit union or individual – goes to court to seize title to the home. The property is then sold to satisfy the mortgage. If the sale price is not equal to the amount owed, the lender in some cases can pursue you for the balance. And the unpaid amount may affect the amount of federal income tax you owe.

 

A foreclosure remains on your credit report for seven years.

 

 

Most individual bankruptcies are either Chapter 7 or Chapter 13 filings.

 

Chapter 7 provides for the sale of a debtor’s property and the distribution of the proceeds to creditors. Some state’s exempt certain property—such as a first home -- from liquidation.

 

Chapter 13 provides for an adjustment of the debts of an individual with regular income. It allows a debtor to keep his or her property and reorganizes the debt so it can be paid over time -- usually three to five years.

 

A Chapter 7 bankruptcy stays on your credit report for 10 years, but a Chapter 13 for only 7 years because it requires repayment of debt.

 

“One way to look at it is it is a reward for repaying at least some part of the debt,” Griffin says. “So there is some benefit to declaring Chapter 13 as opposed to Chapter 7.”

 

Some people faced with the prospect of bankruptcy may try to resolve their financial problem through one of two less drastic measures: a debt settlement plan or a debt mediation plan.

 

A debt settlement plan is an agreement you strike with your creditor to pay a portion of what you owe in exchange for the creditor’s forgiveness of the balance of the debt. There are companies that sell debt settlement services, but they generally will not get a better deal for you than you would get by dealing directly with your creditors, according to Gail Cunningham, vice president for public relations at the Maryland-based National Foundation for Credit Counseling, an association of nonprofit credit counseling agencies.

 

A debt settlement plan will stay on your credit report for seven years, Griffin says.

 

A debt management plan is worked out by a certified credit counselor at a credit counseling agency, who negotiates with your creditors to have fees stopped or reduced and payments dropped to a level that suits your income. A debt management plan will require that you have your debt fully paid off in five years, Cunningham said.  You can get in touch with a certified credit counselor by phone or e-mail, or in person. Visit nfcc.org for contact information.

 

A debt management plan will stay on your credit report for seven years. The fact that you used a debt counseling program may also be noted on your credit history, but it will not affect your credit score, Griffin says.

 

 

On the other hand, positive information about open loan accounts stays on your credit report indefinitely, Griffin says. If those accounts are closed without any dings, the information remains part of your credit history for 10 years. That means they can outlast any problems caused by foreclosures, bankruptcies and the like, which age off your report more quickly.  “That helps you rehabilitate your credit,” Griffin says.

 

So how bad is going bankrupt or losing your home? Bad. 

But, Griffin says, “It is not the end of the world. It is credit.

You can recover.”