What Affect Do Foreclosures Have on Credit Scores?

The conventional wisdom is that a short sale or deed in lieu of foreclosure won't hurt your credit as much as a foreclosure will, but nobody really knows how a foreclosure, short sale, or deed in lieu of foreclosure will affect your credit score. Only the folks who set the credit scores can really tell you—and they won’t, because certain important factors used to derive credit scores (and the criteria used in follow-up “manual” examinations) are kept confidential as a business secret.

Until recently, credit practices were fairly standard, and it was possible to more or less predict what impact a particular action would have on a person’s credit score. For example, someone filing for bankruptcy was usually able to rebuild his or her credit in two years to purchase and finance a car and five years to purchase and finance a house. It’s now virtually impossible to predict the availability or cost of consumer credit after a foreclosure, short sale, deed in lieu of foreclosure, or bankruptcy. Currently, subprime real estate loans are very hard to come by. Whether this tight credit will spread to credit cards and car loans remains to be seen.

Also, in past years credit grantors would subjectively assess the raw information in a credit file when deciding whether or not to grant credit and at what interest rate. For instance, they might have seen that you did a short sale and given you a break for at least being responsible enough to sell your house rather than just walking away or giving the house back with a deed in lieu of foreclosure Now, however, this type of examination is made only if your credit score is low enough to trigger it. And because you already have two strikes against you because of your low credit score and your short sale or deed in lieu of foreclosure, the results will seldom cheer you.

Even if current information we do have about credit scores indicates that a short sale or deed in lieu of foreclosure is marginally better for your credit, things might change. Credit card issuers are reporting record high default numbers. Also, because of trillion-dollar government deficits (financed by foreign loans and the printing of money), it’s probable that we’ll be living with inflationary pressures for some time to come. Because issuing credit expands the money supply, the government will likely rein in the credit industry to help fight inflation when the time comes.

All this means it’s next to impossible to predict what role, if any, credit scores will play in the new economy. If consumer credit gets tight enough, the very concept of the credit score may be an artifact of times gone by. For now, the best and most current information on the subject of consumer credit, and how to rebuild it, can be found in Credit Repair, by Robin Leonard and John Lamb (Nolo).