Consequences of Foreclosure
How Does a Foreclosure Affect Your Credit?
Foreclosure can have lasting impact on your credit. If you are considering foreclosure, it's important to understand the consequences before moving forward.
How Long Does Foreclosure Affect Your Credit?
Once a home is lost to foreclosure, the homeowner’s credit score could drop dramatically. According to FICO, for borrowers with a good credit score, a foreclosure can drop your score by 100 points or more. If your credit score is excellent, a foreclosure could reduce your score by as much as 160 points. In other words, the higher your credit score the more impact a foreclosure will have.
Typically, it will take three years or more of on-time payments to restore the credit score. If the foreclosure is an isolated event and the borrower's credit is otherwise sound, consumers may be able to recover more quickly. It can take anywhere from three to seven years to fully recover.
A low credit score due to foreclosure can result in expensive interest rates and limited credit, making financial recovery difficult.
When Will a Foreclosure Start Impacting Your Credit?
Your mortgage lender will typically report any payment that is 30 days later or more to the credit bureaus. This means that before the foreclosure process ever begins, your credit will be negatively impacted by each late payment. Most banks wait at least 90 days after failure to make payment to begin foreclosure proceedings. The process can often take several months or more to be completed. It is realistic that if you have not made payments, by the time a foreclosure is completed, your credit score could be reflecting at least six months of missed payments. This can have a significant impact on your credit.
How Is Your Credit Score Calculated?
The components of a FICO score consist of payment history, amounts owed, length of credit history, new credit, and types of credit used.
Foreclosure Tax Consequences
While it's common to hear about the credit consequences of foreclosure, not everyone considers the tax consequences. A foreclosure brings about a property title transfer and subsequent tax assessment. Most property owners do not realize that by losing their home to foreclosure, there are likely going to be tax implications.
Any time debt is forgiven; it is considered a taxable event. The IRS states that any borrowed money that is not paid back is considered as income and is taxable. A mortgage involves the bank or lender granting funds to the owner in return for a promise to pay the funds back. When the owner begins repaying the money, this money is not claimed as income on their tax return. If, however, this debt amount is canceled or forgiven, it will have to be included as income for tax purposes. The loan amount is considered income because there is no longer an obligation to repay the lender for the same.
Once the property is sold by the lender, the tax consequences come in. The original loan was based on the value of the property, but these values keep changing. If the property is sold for less than it was originally worth, and the bank is unable to recover all the money it had lent, the balance is reported to the property owner and the IRS on a Form 1099-C, Cancellation of Debt. This amount is considered as income and must be reported on the homeowner’s income tax form leading to capital gains and income tax applicable.
Typically, the only instance where such income is not taxable is when debts are discharged through bankruptcy. Canceled debt tax may apply if the homeowner is labeled insolvent or with reference to certain farm debts and non-recourse loans. It's always the wisest and safest course of action to consult a tax professional to advise on your specific situation and what you can expect.
Buying Another Home After Foreclosure
It is common, following a foreclosure, for the borrower to seek a future mortgage. While it might take some time and effort, it is certainly not impossible to purchase a home following a foreclosure. To qualify for a future mortgage loan, most lenders will require a credit score above 620. Most lenders will also require a waiting period before they would consider a loan application.
If there are documented extenuating circumstances, they could have a direct bearing on the number of years to wait to get a conventional loan.
One of the best options for obtaining a mortgage after foreclosure is with a federally insured FHA loan. Three years is the minimum time required between the completions of foreclosure until approval of an FHA loan, regardless of any extenuating circumstances. FHA borrowers still have to prove good bill-paying habits since the foreclosure for any approval as well.
There is Hope After Foreclosure
At CESI, we understand that a foreclosure can be a difficult experience. If you are concerned about debt and fear that foreclosure could result, there is help available. Check with a Housing Counseling Agency in your area to see if they have programs and assistance that can keep you from losing your home.
If you would like to speak to a certified credit counselor for a free financial assessment, we'd love to help. Taking action before an event like foreclosure might just be enough to turn things around and get you on the right track. Contact us today!