If you can’t afford your mortgage payment any longer you may consider walking away from the home, giving it up in foreclosure. Another option you have is to talk to your lender about a short sale. Both options result in you losing your home, but one option may affect your credit score a little less, depending on the circumstances.
It’s important to understand that either situation is bad for your credit score. You are going to suffer a hit as a result of not fulfilling the terms of the loan. But, you can minimize the damage caused with a few simple tips.
Borrowers that choose foreclosure are usually the ones that are so far behind on their mortgage that they cannot catch up even with a short sale. Lenders are usually willing to negotiate a short sale early on in the process. If you miss a payment or two, you better start having those conversations with your lender about the short sale. If you know you can make the payments up, though, you may even discuss a payment arrangement. If not, the short sale will be your next best bet.
If you are beyond the one or two late payments and need to give your home up, foreclosure will hit your credit score between 100 and 200 points. Now if you already have bad credit 100 or 200 points can really put you in a bad situation. If you have great credit, though, and something outside of your control make it impossible to make your mortgage payments, that 100 – 200 points will bring your score down, but it may not be impossible to recover. Your credit score won’t be as low as someone’s credit that was already low.
Choosing a Short Sale
If you can help it, the short sale is usually a little less damaging to your credit score. There’s one reason why – you make good on the debt. While you aren’t paying the loan back in full, you are paying back the full amount that the lender agreed to settle on in the short sale. That’s the difference. In a foreclosure, you just walk away from the loan, leaving the lender with your home and a large hole in their bank account.
When you choose a short sale, you do give the bank money; it’s just less money than they originally lent you. Lenders are often willing to take the short sale because they will get a good portion of their money back, but not necessarily all of the money that they lost. If you pay the balance back as agreed, the lender will mark your credit report ‘settled or paid as agreed.’ While this isn’t the ideal mark you want on your credit report, it at least lets other lenders know that you do your best to make good on the debt. Your credit score will fall, just not as much as with a foreclosure.
What Can You Do to Fix Your Credit?
No matter which decision you make, you’ll need to pick up the pieces and fix your credit. Whether you choose foreclosure or short sale, you’ll want to use some of the following tips to bring your credit score up again:
- Get a secured credit card – If your credit score drops dramatically, you’ll want to re-establish good credit by starting with a credit card that requires you to put down a deposit. The credit card company holds onto the deposit in case you default on your bill. If you don’t, they don’t use the security deposit. Having this type of credit with positive use for 6 months or so can help you re-establish your credit.
- Be an authorized user – If you have family or close friends that have credit cards that report authorized users to the credit bureaus, try becoming one. This way you can get the good report on your credit report as well.
- Mae your payments on time – Make sure you stay on time with the payments of the debts you already had. Don’t let everything fall down the tubes or you could really wipe out your credit score. Timely payments can really help boost your credit score.
- Keep your credit utilization rate down – Don’t go crazy and charge a lot on your credit cards. Keep your outstanding credit at less than 30% of your total credit limit for the best impact on your credit score.
Foreclosures and short sales can hurt your credit, but the damage doesn’t have to be forever. Figure out the best option for you by talking with your lender the minute you know that you are in trouble. If a short sale is an option, take it. This should have the least effect on your credit score. If it’s not, just make sure you are continually trying to improve your credit score after the foreclosure happens and after two years you’ll be able to apply for a mortgage again.