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17 Dec 2013

Bankruptcy or Foreclosure – Which is worse for Your FICO Score?

Whether you're struggling to make mortgage payments or seriously behind, foreclosure is a scary proposition. Not only would this be devastating to your lifestyle, but you may be concerned about its impact on your credit. But isn't every major financial problem going to damage your credit? When it comes to your FICO score, is it much different to go through foreclosure or bankruptcy, complete a short-sale, or request a loan modification from your bank?


While it may seem to be a minor, there is actually a significant difference between these options. Before you decide what to do, find out which activity will have the greatest impact on your credit score.

Your credit score

Every person is assigned a number by a credit scoring company that predicts your likelihood of default on payment obligations. This number is called a FICO score. Each credit reporting agency uses a different set of factors and calculations to get to this score, but most of the information they use is contained within your credit report. For this reason, it is very important to look at your credit report often, just in case there are any errors in reporting.

A FICO is required in 90 percent of all mortgage applications, so it is a number that could impact both your buying power and interest rate.

What influences your FICO score?

Payment history accounts for 35% of this score, which means if you pay your bills late your number will be lower. The more recent the problem, the more it will affect your score.

Outstanding debt accounts for 30 percent. If the amount you owe to a creditor is close to the credit limit, this will negatively impact your credit score. Also, carrying a balance on several accounts will reduce your score because it will seem like you are overextended.

Length of credit history accounts for 15 percent, which means the longer you've had an account open, the better it is for your score. However, new credit (10 percent) shows you've been applying for many new credit limits, which could negatively impact your score.

Finally, the type of credit you have will account for 10 percent. FICO looks for a healthy mix, including both revolving and installment loans, but this will only be important when there is little information available to determine your score.

What happens when you file for bankruptcy?

A bankruptcy filing will show up on your credit report for 10 years, which is three years longer than most other negative information, such as short-sales, foreclosures and loan modifications.

The impact of foreclosure on your credit score

If your credit score is high to begin with, any kind of financial distress will cause a deeper dive than if your score was already low. In fact, borrowers with higher FICO scores could see a drop of 100 or more points. Additionally, it will take longer to get back to an original score if that score is high, but the number of years it takes to rebuild will largely depend on your future payment history and debt load.

If you have excellent payment behavior and your available credit increases, your score will improve more quickly than if you continue to make some late payments and are remain overextended.

Foreclosure, bankruptcy and short-sale often impact borrowers' scores so dramatically because borrowers only resort to these measures when they are seriously delinquent.

What about loan modifications and forbearances?

If your lender reports that you are "paying under a partial agreement," this could have a negative impact on your FICO score, but a lot depends on how your loan modification is reported. Either way, if you are no longer paying your mortgage as originally agreed, it will have some impact on your score.

Bankruptcy is worse for your credit score

Statistics from FICO indicate that bankruptcy is slightly worse for your credit score than foreclosure, forbearance, short-sale, or a loan modification. When comparing foreclosure to short-sale, borrowers who faced foreclosure took longer to rebuild credit than those who completed a short-sale. This can be attributed to the fact that foreclosure is normally triggered by such life events as a job loss, divorce or medical problem, conditions which will likely continue long after the foreclosure.

Keep in mind, however, that these statistics reflect the average situation, and everyone's financial situation is different. ¬¬

Photo Courtesy of Stuart Miles / FreeDigitalPhotos.net

Stephen H. Swift

Managing Attorney
Law Office of Stephen H. Swift, P.C.

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