Many Americans with sub-prime or adjustable rate mortgages lost their homes when payments suddenly spiked and they were unable to pay the higher rates or refinance their mortgages at more favorable rates. A sudden decrease in property values left some homeowners owing more on their mortgages than the value of their homes, making it difficult to sell their property and pay off their debt. Inevitably, many homeowners were foreclosed on, voluntarily or involuntarily. After all, why continue making payments on an investment that will not appreciate to its original value for another decade?
A foreclosure, similar to a bankruptcy, is a serious blemish on your credit report and it remains in your history for seven years. This does not mean that you will be unable to get credit in the future, although you may have to pay higher interest rates in the short term.
While this can make obtaining new lines of credit difficult, there are ways of improving your credit score after foreclosure. If the American economy is as resilient as we all think it is, the next decade should prove to be a time of great wealth creation and a good credit score could be your ticket to borrowing money and making investments.
While some credit card companies may cancel cards after a foreclosure, as long as you continue to make regular payments on the card and do not make major purchases, you may be able to keep your credit accounts. If the credit card company contacts you to cancel your account or raise your interest rates, contact them and point out that you have been paying your bills on time and negotiate to keep your current credit limit and interest rate. Sometimes, these are just automatic adjustments when certain notices pass across a sales reps desk. In many cases, the company will not change your credit limit and interest rate if it is reassured you will keep making timely payments on your debt.
Use credit cards to pay for household expenses like gas, groceries and bills, and pay these charges in full at the end of each month. It is important to maintain consistency and continue to use the cards to rebuild your credit score and establish a good payment history after a foreclosure.
Secured credit is easier to get than unsecured credit and many banks and credit card companies offer secured credit cards. Secured cards require that you make a deposit with the bank or card company and your credit limit is equal to the amount of your deposit. Cardholders cannot access the money in the account as long as the credit line is open, ensuring the lender will not lose money on credit loans made to you.
Secured credit cards differ from debit cards because they make regular reports to major credit bureaus. Interest, fees and penalties apply just as they do on unsecured cards; however, not all secured cards are created equal, so it is smart to shop around and check consumer reviews to find the best cards. Some credit cards offered by companies on the internet do not make reports to major credit bureaus and others may have high interest rates or fees.
Secured loans also help rebuild credit scores, although loans may not improve scores as quickly as credit cards. Loans may be secured with cash or property, but beware of car loans that target people with poor credit. These loans are often offered by used car sellers and have high interest rates on cars that may be priced at or above book value. Title loans and other unconventional financing options are usually costly and will not significantly improve your credit score.
[Free Resource: Check your free credit report and score]
Pay All Your Bills on Time
Late payments drop credit scores quickly, especially if the retailer or company has a policy of immediately reporting missed payments or defaults, so it is crucial that you pay all your bills on or before their due dates. This includes cell phone and utility bills as well as any loans or credit card accounts. Because 35% of how your credit score is calculated relates to payment history, consistently repaying debt on time improves your credit history and can eventually raise your credit scores to the level they were at before your foreclosure. Although it will take time to rebuild your good credit rating, a good credit history goes a long way in restoring the confidence of lenders who may decide to lower your interest rates and raise your credit limits, leading to lower credit utilization and also improving your credit history. As you can tell, good financial habits build on each other.
Do Not Incur New Debt
Wait until your credit score reaches at least 650 before applying for additional credit since a good to excellent FICO score will dramatically improve your chances of being approved for a new credit card or loan. First, each new application for credit is followed by an inquiry to a credit reporting agency. Too many inquiries in a 12 month period negatively lower your score. Furthermore, about 15% of your score’s calculation is based on the length of your credit history. This figure is incorporated as the average number of years and months your accounts have been open, and compared against a benchmark. A handful of new accounts will lower the average length of time your accounts have been open, and thus adversely affect your score again. Instead of opening additional accounts or incurring new debt, accelerate payments and pay off your mortgage or save more money each month.
Check Out Credit Unions
Most Americans are eligible to join a credit union. Credit unions function much like banks, but operate on a non-profit basis – they exist solely for the benefit of their members. Credit unions must create enough revenue to pay interest on deposits and cover the cost of their services, but they do not have to create profits for shareholders since they are entirely owned by members. Most university alumni and professionals have access to at least one credit union.
Credit unions charge lower interest rates than banks or credit card companies and may issue dividends to members if they have a surplus of cash at the end of a fiscal year. Only members can obtain loans or cards and because these institutions are fairly small, they offer better customer service and personalized attention. This can make it easier to qualify for financial products or services at lower interest rates.
Increase Your Income
As a business owner myself, I understand that this last part is easier said than done, but don’t you agree that most of your financial woes would disappear if you just had more money? Whether this means you or your spouse need to take on a part-time job, become a freelancer or consultant, work online, or find a way to make money from home, an extra income stream can help you pay off your debt faster and offer a financial cushion for the future. Many Americans can turn a hobby into a side-business on the weekends, and might be surprised to find that a little extra effort could turn a home-based business into a successful full-time commercial venture that could change your family’s finances forever. Start slow, risk very little, and see what happens.
The recent recession coupled with the sub-prime mortgage crisis has forced millions of people to walk away from their homes and face foreclosures, but foreclosure should be viewed as a temporary setback rather than a disaster that will financially cripple you for a lifetime. As long as you keep other payments current and do not incur additional debt, you can overcome this weakness in your credit history and continue to work towards financial stability for you and your family.
Gary Dek is a former investment banker and private equity analyst living in California. Don’t hate him – he had nothing to do with the mortgage crisis and the recession. He writes at Gajizmo.com and is always looking for ways to make and invest money.
[Free Resource: Check your free credit report and score]