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Rebuilding Credit and Preventing Displacement

One consequence of foreclosure is damage to former homeowners’ credit scores, which can make it difficult to qualify for new housing or get approved for a loan. To help families stabilize and restore their credit over the long term, communities can offer or expand programs that provide financial education and counseling.

Communities can also help by increasing owners’ awareness of the credit impacts of foreclosures and of ways to reduce the negative effects. Expanding the use of foreclosure prevention hotlines and borrower-lender outreach sessions can help families access foreclosure prevention counseling early and make good decisions about what to do if there is no hope of making the mortgage more affordable. Families may be able to reduce the damage to their credit through a graceful exit that avoids foreclosure or serious delinquency.

An evaluation of homeownership education and counseling provided by the Indianapolis Neighborhood Housing Partnership found that families’ credit scores were significantly improved through the program’s financial education and counseling, helping to improve their borrowing power by an average of more than $4,500. These improvements may represent the difference between qualifying and not qualifying for a new home or an affordable mortgage.

How are Credit Scores Affected by Foreclosure?

Record of a foreclosure will remain on a borrower’s credit history for seven years, but how does foreclosure impact credit scores and how long does it take to recover? The study, Foreclosure’s Wake: The Credit Experiences of Individuals Following Foreclosure, by researchers at the Federal Reserve Board in Washington, D.C., take a closer look at credit recovery by examining credit score trends of borrowers pre- and post-foreclosure, and how access to credit (reflected by individual credit scores) is affected by foreclosure.

Using a sample of over 345,000 credit score records for individuals that faced foreclosure between 2000 and 2009, the researchers track long-term recovery, defined as an individual’s return to their credit score pre-delinquency. The findings suggest that, in some cases, credit scores may improve in as little as two years, while others may still have credit damage 10 years after foreclosure. How long it takes for a borrower’s credit score to rebound largely depends on the credit score prior to foreclosure.

Individuals who enter foreclosure with a “subprime” score (below 660) typically recover faster than those that enter foreclosure with “prime” credit score (above 660) because they do not have as far to catch up to achieve their pre-foreclosure credit scores. Data show that 60 percent of subprime borrowers who experienced foreclosure between 2000 and 2006 recovered within two years from when their mortgage entered foreclosure. Within eight years, 94 percent of subprime borrowers in this cohort were fully recovered to pre-delinquency levels. The recovery time for prime borrowers, however, is much different. Data show that only 10 percent of prime borrowers recovered within two years. One-third of prime borrowers do not see their credit score fully recover, even 10 years after the mortgage entered foreclosure.

The study concludes that credit recovery time appears to reflect a change in borrower behavior that leads to greater levels of delinquency in all types of consumer credit. The change in the behavior may be one or a combination of the following scenarios:

  • Foreclosure may alter borrowers’ financial circumstances and make them prone to future delinquencies.
  • Foreclosure may have been the result of an event (such as a health condition, job loss, etc.) that affects borrowers’ abilities to pay any of their bills.
  • Foreclosure may influence consumer preferences about maintaining a good credit rating and reduce the incentives for making payments on time.
  • Considering the widespread economic problems and high unemployment rate during the late end of the study, the researchers estimate that individuals who experienced foreclosure between 2007 and 2009 may have even slower recovery times than those who experienced foreclosure earlier in the decade.

Preventing Displacement

When families are forced to leave their homes after foreclosure, it puts both the family at risk of homelessness and the property and surrounding community at risk of blight. By helping residents to remain in place after a foreclosure, policymakers can reduce vacancy and abandonment that would otherwise destabilize communities. The Protecting Tenants at Foreclosure Act helped to prevent displacements of renters after foreclosure, but programs can also help former owners stay in place even if a foreclosure cannot be avoided.

An approach that goes by several names – – can enable at-risk homeowners to stay in place after foreclosure and rent the property back from the new owner at market rates. The term “rentback” describes the broad approach, while the other names are better used for specific variations. Rentback approaches fall into one of three broad categories: (1) own-to-rent programs that help owners rent their former home from its new owner, (2) own-to-rent-to-own programs that help owners eventually repurchase the property after renting it and rebuilding their credit, and (3) right-to-rent laws that create a right to rent the property back at market rates for a specified period of time after foreclosure.

Both Fannie Mae and Freddie Mac offer own-to-rent programs to help keep former owners in place after foreclosure. Fannie Mae’s program, Deed for Lease, allows owners to reduce the damage to their credit through a deed-in-lieu-of-foreclosure and then rent the property back with a 12-month lease at market rents. Freddie Mac’s program, called the REO Rental Initiative, gives former owners the option of staying in place with a month-to-month lease. Communities can help to increase awareness of existing own-to-rent options and may also consider implementing programs that acquire owner-occupied properties in foreclosure and rent them to the former owner. An own-to-rent-to-own approach is similar, but uses a lease-purchase model to eventually allow the former owner to repurchase the home on sustainable terms.

The right-to-rent approach was developed by the Center for Economic Policy and Research and was introduced in Congress in 2010 but was never enacted.

Fannie Mae offers a variation of the rentback model for renters, called the Tenant-in-Place rental policy. The Tenant-in-Place policy enables renters living in foreclosed properties to enter into a new 12-month lease with Fannie Mae at market rents. Depending on households’ lease terms at the time of foreclosure, opting to participate in this program may or may not be helpful for renters. Participating could extend housing stability for tenants, but it could also raise the rents if the rents in the existing lease were below market. Another approach to keeping families in their homes after foreclosure involves not renting the property back, but selling it back to them after foreclosure.

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