If you've fallen behind on your mortgage, if your home is currently underwater or if you don't foresee being able to continue making payments on your home, then two options you may consider are foreclosure or a short sale. While both of these can have a negative effect on your credit score, they both act differently. Here's a closer look at each option and how they can impact your score:
Foreclosure occurs when you've defaulted on your mortgage loan and the bank reclaims possession of your home.
The good: Foreclosure allows you to walk away from your home, which is valuable if your current mortgage is higher than the home's value.
The bad: Foreclosure takes a heavy toll on your credit score and will stay on a credit report for up to 7 years. It's estimated that a score can be docked from 100 to 150 points after a foreclosure - but that's not the worst part about it. The worst part is that you may not be eligible to purchase another home or qualify for a loan for at least 2 to 5 years, depending on your state laws.
A short sale is an agreement with the bank that you'll sell your home for less than what you owe on it in the event that you can no longer make payments as-is:
The good: You - and not the bank - control the sale. It's also a more responsible way of walking away from your home and being able to qualify to buy another home immediately, in some circumstances. However, if you've fallen behind on payments, it may be at least 3 years before you can qualify for an FHA loan.
The bad: Your credit score will still take a hit - from 50 up to 130 points in some cases. And although credit bureaus don't show "short sale" on a report, it may still identify that you either settled for less or paid in full for less on a report, which can jeopardize future loan opportunities.
If we were to give you a credit tip, it would be to not bite off more than you can chew when it comes to buying a home in the first place, as this reduces the chance of foreclosure and short sale. And unlike other credit repair situations where debt management or financial responsibility can go a long way toward upping your score, foreclosure and short sales can be that warning sign on your credit report for several years, making it very difficult - if not impossible - to get approved for a loan, let alone good interest rates.
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