A Foreclosure Does Not Hurt Your Credit Score Nearly as Much as You may Think.
Have you ever heard someone tell you that a foreclosure will ruin your credit score? From a TV Commercial? A Realtor? A Banker?
The Federal Reserve Bank of Cleveland undertook a study to determine if these Cassandric prophesies actually turned out true for real people. Turns out, the banks and realtors and credit repair companies are worse at making predictions than Miss Cleo.
This paper shows the opposite: foreclosure itself has a very limited impact on a borrower’s
credit score in most cases. Using individual-level credit report data that has been merged with
loan-level mortgage data it is estimated that the very first missed mortgage payment leads to
the biggest reduction in credit scores. The effect of subsequent loan impairments on the credit
score is increasingly muted. Specifically, based on the estimates, the impact of a transition from
current to 30-day delinquency on the credit score is a decline of 51 points (relative to households
that stay current and have otherwise comparable observable characteristics). For a transition to
60-day delinquency, 90+-day delinquency, and foreclosure, the effect is a 25-, 14-, and 6-point drop, respectively.
Yes, you read it right. Foreclosure only drops your score an average of 6 points. Why? Because once you’ve missed a payment, you’ve done most of the damage already. There is barely any practical difference between being 2 months late and having actually lost your home in foreclosure.
You can download the report at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2514370#%23
This isn’t to say that you should be excited about losing your home in foreclosure. Not at all. But as I always advise my clients: NEVER BASE FINANCIAL DECISIONS ON HOW YOU THINK IT WILL AFFECT YOUR CREDIT. If a bank, realtor, foreclosure rescue operation, or anyone trying to make money off you says that a short sale or deed-in-lieu or some “foreclosure alternative” is going to help you because a foreclosure will kill your credit for years to come, they are lying to you.
Sometimes, it is best to let the bank take their house back and just move on. If so, that’s what you need to do.
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