How Does Foreclosure Affect Your Credit Score?

A foreclosure is not only one of the most costly and stressful events that can happen to a homeowner, it can also have an incredibly destructive effect on your credit score. 

A foreclosure is when you default on a mortgage and the lender takes legal possession of your home. It has a negative impact on credit scores because most mortgage lenders report payments to one or both of Canada’s credit bureaus. So, if you make all your payments in full and on time, having a mortgage can boost your score. On the other hand, missed mortgage payments can significantly decrease your score. 

That being said, there are some lenders who may not report mortgage loans to credit bureaus so you may want to ask your lender about their policy.

How Does a Foreclosure Work in Canada?

Most people need to obtain a mortgage when they buy a new home because they can’t afford to pay for a property on their own. To protect a bank or mortgage lender from a borrower defaulting on payments, mortgage contracts contain a clause (which is why it’s always a good idea to read your mortgage agreement thoroughly) that gives the lender the right to take possession of the home if payments are not made. 

The foreclosure process usually involves a lender filing a Statement of Claim with a court. The mortgage holder has a set period of time in which to respond and try to provide a defence as to why they missed payments. If the court agrees with the financial institution providing the mortgage, your mortgage will officially be deemed in default and the lender can then ask for a foreclosure order. The lender will then evict the homeowners and take possession of the house, and will then sell the property to recuperate their investment.

A foreclosure is the most serious action a lender can take against a homeowner, and is usually reserved as a last resort because the process is expensive, lengthy and can involve the courts. Often the lender will try to work something out with the homeowner to make payments more manageable before initiating a foreclosure proceeding. 

Note that a lender may initiate a power of sale on a property instead of a foreclosure, generally depending on which province or territory you live in. A power of sale is similar to a foreclosure but has less court involvement. Speak to your mortgage lender about the differences. 

How Long Will a Foreclosure Remain on Your Credit Report?

A foreclosure has a huge impact on your credit score. That’s because it’s considered the same as defaulting on a loan and will therefore stay on your credit report for approximately six years. 

Can You Remove a Foreclosure Earlier from Your Credit Report?

Sadly, credit bureaus have very strict rules around how long something stays on your credit file. There’s likely nothing you can do to erase a foreclosure from a credit report earlier than the full six years. However, if you have a legitimate issue and the foreclosure was not officially recognized by the courts or you worked out a last-minute deal with your lender but the foreclosure is still listed on your credit reports, you can file a dispute with the Canadian credit bureaus (Equifax and TransUnion) by following the dispute process listed on their websites.

How to Prevent a Foreclosure?

If you’ve started to fall behind on payments and fear that you may not be able to get back on track, there are steps you can take to avoid losing your property. Remember, just as you want to keep your home, lenders want to help you keep your mortgage so they can get their money. For that reason, it’s always worth reaching out to your lender for help. 

Here are some options that may allow you to prevent a foreclosure.

• Ask for a deferral. While rare, some mortgage lenders may be willing to give you a payment deferral if you’ve hit a rough patch. 

• Renegotiate. See if you can renegotiate the terms of your mortgage. You may be able to extend your amortization period or space out your payments more. 

• File a consumer proposal. Consult a licensed insolvency trustee to see if you can file a consumer proposal. A proposal can give you breathing space to get your finances back in check so that you can afford to resume your mortgage payments. 

How Soon After a Foreclosure Can I Buy a House?

Because a foreclosure will have such a major negative impact on your credit score, the hard truth is that you’ll likely have a very difficult time finding a bank or mortgage lender willing to take on the risk of lending you a substantial amount of money. 

Credit scores are a key factor that lenders use when deciding whether or not to lend someone money, and defaulting on a big loan — rightly or wrongly — tends to make potential lenders assume you’re not creditworthy. 

If you just can’t wait for the six years to pass (which is how long a mortgage default stays on your report), there may be alternative lenders who will give even those with bad credit and low credit scores a mortgage. However, the kinds of lenders willing to take a risk on someone with bad credit tend to charge very high interest rates and may have lots of additional fees. For the sake of your financial health, it’s likely best to wait until you are eligible for a mortgage with a traditional lender.

How to Rebuild Your Credit After Foreclosure?

You don’t have to wait for six years for a foreclosure to come off your credit report to start thinking about how to fix your faulty credit. You can get your score on the right track by following some simple steps:

Monitor your credit report and score regularly 

Regularly monitoring your credit report is the best way to ensure you’re on top of your overall financial health. Mistakes do happen, and by making it a habit to review your credit score and report you’ll be able to catch incorrect credit information before it has a major impact on your score. 

Be sure to regularly review things like your personal information, employment status, payment history and whether or not there are any unrecognized credit accounts on your file. By checking your report often, you’ll not only ensure that your score stays on track, but you’ll also prevent serious issues like credit fraud. 

Dispute inaccurate information

If you find any inaccurate information on your credit reports, reach out as soon as possible to the credit bureaus to have the errors corrected. Both Equifax and TransUnion have specific credit report dispute processes you can follow to ensure errors are quickly fixed. The sooner you get an error sorted, the sooner your credit score can recover. 

Make on time payments

Even as little as one late payment can negatively impact your credit score significantly. That’s because payment history is the single largest factor influencing your score, accounting for 35% of your overall rating. If you tend to forget to make mortgage payments, set up a payment due alert or arrange for automatic payments.  

Get a secured credit card

Secured credit cards are a great tool to rebuild credit. They are also easy to get even if you have bad credit, because cardholders must provide a security deposit. The security deposit acts as collateral, guaranteeing that your lender won’t be out of pocket if you default on your credit card payments. Even though you must provide a cash deposit (which you don’t have to do with a regular credit card), secured credit cards are similar to traditional cards in that your payments are reported to credit bureaus. As long as you make on-time payments, a secured card will steadily boost your score. 

Apply for a credit building program

Credit building programs are not very common yet in Canada but they can be a good tool to boost your score. With a credit building program, you don’t get money but actually make payments to a lender who puts your money into an account for safekeeping. Your lender reports your payments to a credit bureau just as they would if you had taken out a traditional loan. At the end of the loan period, you get access to the money in the account and, as long as you made all your payments, your score will also have increased.  

Create a budget

Ever notice how at the end of the week you have no idea where you spent all your money? Well, with a budget, you’ll know exactly where your money is going and be better able to see where you can save on expenses. Creating and sticking to a budget is one of the easiest things you can do to strengthen your financial health.

Keep a low credit utilization ratio

Credit utilization (which is the amount of credit you’re using out of the total amount of credit you have available) accounts for 30% of your score. Ensuing you’re never using more than 30% of your total available credit will improve your score.

Avoid submitting too many credit applications

When you apply for credit, a financial institution will access your credit report to see if you’re creditworthy. Each time a potential lender checks your report, it can cause your score to decrease slightly, so it’s wise not to apply for too many credit products in a short space of time.

Beware of credit repair scams

By and large, the only way to repair credit is by nurturing healthy financial habits over a long period. It’s a process that requires patience and hard work, so beware of anyone promising quick credit fixes. If you’re unsure, contact the Financial Consumer Agency of Canada to confirm if the program is legitimate. 

Final Thoughts

There’s no way to sugar coat it; the fact is that getting a mortgage after a foreclosure will be an uphill battle. While there’s really no way to mitigate the negative impact a foreclosure will have on your credit in the short term, over time, with patience and smart financial management, you can slowly repair your score and rebuild your credit. The important thing is to start rebuilding your credit as soon as possible to lessen the overall impact of a foreclosure as much as possible.