Losing Your Home in Foreclosure? You Can Become a Homeowner Again

Let's say you've tried everything to prevent a foreclosure (see my column, ), but nothing worked. You end up losing your home. What do you do to recover your credit so you can eventually own another home?

Let's take a look at one real-life situation.

Michelle (not her real name) had excellent credit (her scores hovered around 800) when she bought her San Diego townhouse in 2004. She put 20 percent down and had an interest-only adjustable rate mortgage that would re-set in three years. This kept her monthly payments as low as possible.

In her late twenties, on the fast-track with her company, she was not worried about the reset. She believed both her salary and property value would be much higher in 2007, when she planned to refinance.

During the summer of 2006, Michelle's vibrant life changed forever when she sustained serious injuries in an automobile accident. Her income was cut in half. Thankfully, she had enough savings to cover her expenses for at least a year. She thought she could get back to work before her savings ran out. Sadly, that was not the case. A month before her mortgage reset was scheduled to occur, she tried to work out a solution with her lender. Due to her reduced income and health situation, however,she could not qualify for refinancing.

With credit scores still in the 800 range, Michelle was about to lose her home and her impeccable credit history. Still recovering from her accident, she looked for the best possible option.

In Michelle's case, and for many other individuals faced with foreclosure, that option is not what many experts recommend. Because there was nothing Michelle could do to save her home, she had to make a difficult decision. She had to save her overall credit. Michelle stopped paying the mortgage as soon as it reset, but continued to pay every other bill on time. She did not, as many do, mess up her entire credit history by paying the mortgage until she ran out of money, while amassing a series of late pays on other bills.

Michelle worked with her lender to help the foreclosure move forward as quickly as possible. It took 90 days, which meant she had three months of late mortgage payments and a foreclosure recorded on her credit report.

Was Michelle's credit shot? Yes. Her credit scores dropped down into the subprime 600 range. But the good news is her credit will recover. If she continues to pay all bills on time and keeps her credit card balances below 10 percent of available limits, her credit scores will be back up into the high 700s by the time she's ready to purchase another home.

Michelle's foreclosure will stay on her credit report for seven years. And it will probably be two years after the foreclosure before she can own a home again. There is another factor working in her (and your) favor, however. Because we are currently experiencing a foreclosure epidemic, lenders are likely to evaluate foreclosures during this timeframe differently than they would have in years past, particularly for people whose credit was strong before the epidemic hit.

If you are faced with a situation similar to Michelle's, here's what you do to ensure your credit recovers as soon as possible. Go to AnnualCreditReport.com 60 to 90 days after foreclosure. Pull copies of your credit reports. Make sure the foreclosure information has been reported correctly to each credit bureau. If there are errors, correct them (see my column, ).

Next, you will want to add comments to the credit reports generated by the three agencies: Equifax, Experian, and TransUnion. Briefly explain the reason for the foreclosure. You must do this for each credit reporting agency.

For example in Michelle's case, she said, "Severe injury in an automobile accident forced me to stop working for an extended period. It cut my income in half. The reset mortgage was beyond my means after the accident."

Send your comments to each of the credit reporting agencies with a return receipt requested. Also, ask them to send you an updated copy of your credit report after the comment is added. This becomes part of your permanent credit record. While it will not change your credit scores, an explanation for any unusual credit situation increases your credibility to another lender.

While foreclosure will destroy your credit in the short term, if future creditors can see your foreclosure was caused by a change of circumstances combined with a much higher mortgage payment, you will be able to rebuild stellar credit ratings and purchase another home after two years.

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