Recovering financial credit standing after foreclosure

More than 60 percent of subprime borrowers had recovered within two years, and 94 percent had recovered after eight years. See study. (Photo by Mauro Whiteman)

Individual's credit scores are dramatically altered as a result of home foreclosures, but the scores can be rebuilt through the proper steps.

PHOENIX -- In the wake of the current economic crisis, Arizonans have struggled to reposition themselves financially following a home foreclosure as their credit score plummets.

"Some people are victims of the economy, but a lot of people did not borrow responsibly," said Pat Reiniger, senior loan officer at Suburban Mortgage.

In July of 2011, CardRatings.com ranked Arizona as the fifth worst state for consumer credit standing and the second worst state for foreclosures.

Reiniger said between the years of 2002 to 2006, people viewed the equity in their homes as a source of ready cash.

When the economy began turning downwards, people faced the possibility of home foreclosure because of enormous credit debt and owning homes that no longer were worth their original value, she said.

Foreclosures impact on credit score

According to Fair Isaac Corporation, foreclosures can affect a credit score at 680 with an 85-105 point drop and a score of 780 could cause a drop of 140-160 points.

With a potential of dropping up to 300 points, a higher score prior to the foreclosure will result in greater damages to the score preceding the loss of the home.

"A credit score reduces the cost of borrowing," said Catherine Scrivano, financial planner and owner of CASCO financial group. It affects consumers' ability to borrow money, and those that are able will see an increased interest rate from the lenders.

Once a credit score takes a major hit—like a foreclosure—the borrower's homeowner and auto insurance may increase, and their eligibility to apply for credit cards and loans may suffer. Job security may be endangered because employers look to credit reports to judge if employees are financially responsible, Scrivano added.

There also is misinformation regarding the length of time a person can take to restore their score following a foreclosure.

After experiencing a foreclosure, it takes three years to qualify for a Federal Housing Administration insured loan and seven years for a conventional loan. However, if the delinquency is kept isolated and no further damages are reported, credit score improvement can be seen in as early as two years.

An economic study from the Selected Works of Kenneth Brevoort analyzed a sample of almost 350,000 anonymous credit bureau records from 1999 through 2010 to demonstrate the decline in credit scores following a foreclosure and the length of time it requires to return to a pre-delinquency standpoint.

"The greater difficulty that individuals face in accessing new credit after a mortgage delinquency, including higher costs for the credit they obtain, may make it harder for individuals to weather future shocks, thereby making subsequent delinquencies more likely and reducing an individual's ability to restore a credit score to its pre-delinquency level," the study authors said.

The authors' data reported that there was a dramatic increase in delinquencies beginning in 2006, and those that foreclosed between 2007 to 2009 have appeared are taking longer to regain a healthy credit standing leaving them in subprime positions.

Fixing a damaged credit report

"Firstly, the most effective thing people can do, is get a copy of their credit reports," said Charlie Brandes, Arizona accounting executive of Advantage Credit, Inc. Credit Reporting Services. A report 60 days after the incident will determine if the mortgage delinquency has been accurately reported.

Individuals are entitled to one free copy of their credit reports by all three of the nation's credit bureaus, Experian, Trans Union and Equifax. Brandes recommends visiting annualcreditreport.com for a free copy, which is a site supported by the Federal Trade Commission.

"The hardest thing for most people is learning how to live in an all cash world," Scrivano said.

Those affected by foreclosure have to learn to live within their means by using debit instead of credit and restricting themselves to what they have in their accounts, she added.

Brandes advises individuals to rebuild credit by continuing to borrow money within their means and keeping their credit balances low. This will show lenders that the individual is working to improve their financial standing.

Both Scrivano and Brandes agreed that an alternative for those needing to use credit would be to obtain a secured line of credit, preferably from the same bank as the individual's current checking account.

When dealing with a serious delinquency on a credit score, it is important for the individual to keep revolving accounts open because closing the history could leave the account in a permanent negative stance. Opening new accounts also will further the negative impact on credit scores of those currently in delinquent standing.

Brandes explained that credit bureaus are also working to facilitate the current foreclosure crisis by modifying how they measure individuals' credit.

"Credit bureaus are now experimenting with using rent history as part of their scoring system, which is a huge positive step," he said.

In December of 2010, Experian became the first of the bureaus to allow rental payment histories in their consumers' credit reports, including not only the negative history but also the positive providing another opportunity for consumers to boost their scores.

"Ultimately, it's going to be a long road of repair over the next few years," Brandes said. "People need to seek professional advice."

Advantage Credit, Inc. quick credit tips for maintaining a good credit score

1. Keep revolving balances below 30 percent of the high credit.
2. Have no more than three revolving accounts with balances.
3. Have four or five more revolving accounts that are open but have no balance.
4. Do not co-sign loans. If they make a late payment it will end up on your credit report.
5. Have one or two installment loans. Having no installment loans or more then two can start to have a negative affect on your scores.