How Does a Foreclosure Affect a Credit Score?

One unfortunate side effect from losing your job could be sacrificing an investment in order to stay afloat financially. In some cases, that could mean foreclosing on a home. If you can't afford to make the mortgage payments and all avenues for refinancing have been exhausted, foreclosing may be the only option left. Foreclosure, however, can have quite an effect on your credit score.

Foreclosure

Foreclosing on a home, in basic terms, means that you are no longer making payments to the lender and have given them all your rights as a homeowner. When you foreclose on a home, you are stating that you have no intention of paying back any money owed, forcing the bank to write off your debt as a loss. You'll be evicted and will be forced to live elsewhere. However, the negative credit effects may make finding another place to live more difficult.

Credit Score Factors

A credit score (sometimes referred to as a FICO score) is a tool that lenders and other businesses use to determine your credit worthiness. Credit scores are derived from any financial activity you engage in that involves borrowing money and paying it back. Scores range from 350 to 850 points. The higher your score, the better chance you have of getting credit and repaying it back at relatively low financing rates. A low score could garner you a higher finance rate or no credit at all. Although there are five factors that make up your FICO score, two factors combined--amount owed and payment history--make up 65 percent of it. Those two are also tremendously affected by a foreclosure.

Amount Owed

The amount owed in your credit history accounts for 30 percent of your score. This factor considers not just how much money you owe creditors, but how long the debts have been in existence. Foreclosing on a home will reflect a charge-off amount of whatever your debt was to the lender, which is often in the tens of thousands range. The more recent the foreclosure, the bigger its negative effect on your credit score.

Payment History

The payment history will reflect how many payments you've made on credit accounts, how often those payments were made on time and the status of those accounts when they close. Many homeowners who foreclose, have missed more than one or two payments. If the payments were consistently late, they will also negatively affect your score. As long as the foreclosure showing a spotty payment history remains on the credit report, it will continue to drag the score down. Foreclosures are usually removed from credit reports after seven years.

Point Drop

The total negative point effect is hard to pinpoint since foreclosure situations differ from homeowner to homeowner, but the general average, according to Andy Jolls, a former FICO executive, is at least 200 points. If this is the only negative item on your credit report, the damage will diminish over time. Not only will your score drop, your ability to rent another home could be affected since landlords also do basic credit checks on potential tenants. A foreclosure on your credit history could cause a landlord to think twice before renting out a home to you.