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How Adverse Actions Affect Your Credit Score

How much does it really hurt your credit score if you are late on your mortgage? What if you default and are foreclosed upon? Until recently, all we knew was that it was “bad.” Canceling a credit card was “bad.” Missing a payment was really “bad.” Defaulting was one of the worst “bads.” What we didn’t know was how bad it actually was because the FICO credit score [3] equation has always been a black box.

Well it turns out that we might get a little peek into the black box.

Fair Isaac Corporation, creator of the FICO credit score, recently released some data [4] on how your score is affected by certain “adverse actions” – being 30 days late on a mortage payment, a foreclosure, bankruptcy, short sale, etc. They also estimated how long it would take to fully recover from the action. I personally think it’s a little odd because, well, FICO created the score and the equation that calculates it. 🙂

Either way, the data is still compelling:

First off, it’s always been believed that the better your score, the a negative event would hurt you more. This seems to be the case as a 780 becomes a 540-560 after bankruptcy, a fall of 220-240 points, whereas a 680 falls to 530-550, a fall of 130-150. In this case, it seems like a bankruptcy just pulls you down into the mid-500s and the only reason a higher score is hurt “more” is because they started off at a higher number. A bankruptcy, regardless of where you start, will put you into the low to mid-500s. That makes more sense.

Next, it’s important to note that foreclosure seems to be a better option than bankruptcy, from a credit score perspective. This makes sense because foreclosure just affects your home, bankruptcy can wipe away a wide range of consumer debt. This means that bankruptcy should be something considered only as a last resort.

The biggest gem was in recovery time – the higher your score, the longer it takes to recover. Again, this makes sense because a 780 is supposed to be a very safe credit risk and so when you miss a payment, it’s not surprising it takes more time to recover your higher score.

One key missing point? I’d really like to see a chart for the recovery time that takes into account the score recovery over time. In other words, I want to know how Consumer C’s (780) score moves after being 30 days late. I imagine the score probably recovers fairly quickly for the first few dozen points but then the “score growth rate” falls tremendously.

All in all, some good gems in the tables and it could help some people make more educated decisions.

Big thanks to CreditCards.com [5] for writing about the subject or I’d probably never have seen it!