How a Foreclosure or Bankruptcy Affects Your Credit Score

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When Todd Huettner's clients came to him hoping to qualify for a mortgage, their credit score was in the mid-700s, the sweet spot for lenders, who are looking for borrowers who are likely to pay their bills on time. Huettner, principal at Huettner Capital in Denver, is an independent mortgage broker who has helped people navigate the unpredictable straits associated with obtaining a mortgage. But these clients had a particularly bad patch to deal with:

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When Todd Huettner's clients came to him hoping to qualify for a mortgage, their credit score was in the mid-700s, the sweet spot for lenders, who are looking for borrowers who are likely to pay their bills on time.

Huettner, principal at Huettner Capital in Denver, is an independent mortgage broker who has helped people navigate the unpredictable straits associated with obtaining a mortgage. But these clients had a particularly bad patch to deal with: They had declared bankruptcy two and a half years before.

"A foreclosure, like a bankruptcy, does hurt your score, but it's hard to tell exactly how much by itself, since there are usually other late payments, collections or judgments prior to a foreclosure," he said. "After all, a foreclosure only takes place after not making payments."

Because a credit score is really about how well you handle credit, said Huettner, "late payments are a huge warning sign, and really hurt your credit score. I've seen one late payment lower a score by 100 points."

And as the number of foreclosures has continued to grow, and even those with very good credit scores have had difficulty paying bills these past few years, the credit agencies are changing how they evaluate the risk of consumers defaulting on their loan. The Fair Isaac Corporation and VantageScore, the two companies that determine credit score formulas, have examined consumer behaviors to come up with a new scoring formula. The new scores might take a harsher look at average balances on credit cards and loans, causing an otherwise good score - anything north of 740 - to drop 40 points.

Whatever has caused your credit score to drop - bankruptcy, foreclosure, or late payments - it will take work to get it back up to the desirable mid-700 range (850 is the best possible score; 350 is the lowest.) "When you think about it, you didn't go into foreclosure overnight, said Ken Lin, CEO of Credit Karma, a Web site that provides free access to credit scores and credit advice. "Each one of those things that happens on the way to foreclosure - late payments, missed payments, higher credit balances - will affect your score; it can drop by 200 to 250 points. So it will take time to repair that score."

If you are in foreclosure on your home, you probably won't be looking for a mortgage too soon. But it's not too soon to start trying to repair that credit score. Experts offer these tips to get your credit score to a healthy number again.

Continue to pay your bills. Just because you foreclosed on a property doesn't mean you should pull back from other financial responsibilities. Your credit score is a reflection of how good you are at paying bills. So pay the credit card, the car loan, the gas bill, and any other accounts. Don't skip any payments. Continuing to pay is a way to stop the decline; not paying is a sure way for your score to continue to drop.

Don't close all your accounts. Yes, you just went through a foreclosure, and yes, you would probably like to cut up all your credit cards in order to get a fresh start. But, you need to have at least one credit card that you pay regularly to demonstrate your credit-worthiness. "You have to make on-time payments on accounts for your score to improve," said Huettner. "You can't jut close or not use your accounts and expect your credit to improve." Huettner said to plan for 24 months of timely payments to make a big difference in your credit score.
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Check your credit score regularly. You can request your credit history from each of the three bureaus - Experian, TransUnion and Equifax - free one time per year. And Credit Karma will allow you to request a look every day. While once a day is probably more than you need, especially as you work to repair your credit rating, you should check it every couple of months to be sure that no inaccuracies crop up. "You can dispute anything that you believe is wrong," said Tena Friery, research director at Privacy Rights Clearinghouse, a non-profit consumer education organization. "Take the time to check it; any inaccuracy can affect your score."

Don't max out on available credit. "You should not have a huge debt load," said Lin. "You don't want credit card debt to exceed more than 30 percent of the total limit." This is the number the new credit models will be evaluating. Keeping your loan to debt ratio low will be key in maintaining a high score.

"You can realistically get your score back to the 700s in two to three years," said Lin. "But lenders will be looking at the rest of your credit history at that point, and a foreclosure will not look good to most mortgage lenders. But it is the first step.

And can bring you back to homeownership. Huettner's clients, who were able to keep up with paying bills after a bankruptcy, managed to repair their credit score to the point where, back in the mid-700s and a hefty down payment, they succeeded in obtaining an FHA loan.

Said Huettner, "The more time you have from late payments, the better your score will get."
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