Foreclosure's Wake: The Credit Experiences of Individuals Following Foreclosure
While a substantial literature has examined the causes of mortgage foreclosure, there has been relatively little work on the consequences of foreclosure for the borrowers themselves. Using a large sample of anonymous credit bureau records, observed quarterly from 1999Q1 through 2010Q1, we examine the credit experiences of almost 350,000 borrowers before and after their mortgage foreclosure. Our analysis documents the substantial declines in credit scores that accompany foreclosure and examines the length of time it takes individuals to return their credit scores to pre-delinquency levels. The results suggest that, particularly for prime borrowers, credit score recovery comes slowly, if at all. This appears to be driven by persistently higher levels of delinquency on consumer credit (such as auto and credit card loans) in the years that follow foreclosure. Our results also indicate that the experiences of individuals whose mortgages entered foreclosure from 2007 to 2009 have followed a similar path to borrowers foreclosed earlier in the decade, though post-foreclosure delinquency rates for the recently foreclosed have been higher and, consequently, credit score recovery appears to be taking longer.
However, there are also reasons to believe that the economic shocks that lead to foreclosure may have effects that persist for a longer period of time and that the foreclosure itself may contribute to their persistence. The greater difficulty that individuals face in accessing new credit after a mortgage delinquency, including the higher costs for the credit they obtain, may make it harder for individuals to weather future shocks, thereby making subsequent delinquencies more likely and reducing an individual's ability to restore a credit score to its pre-delinquency level. Foreclosures may also erode a borrower's ability to withstand future shocks by destroying existing wealth or taking away a wealth-building asset. For such reasons, foreclosures may leave in their wake effects that linger long after the foreclosure has concluded.
Our analysis also has sobering implications for the current foreclosure crisis. Our results show that the share of foreclosures that involve borrowers with prime credit scores is substantially higher than it has been in previous years. The post-foreclosure credit experiences of these borrowers appear to be following a pattern that is consistent with what was observed for similar borrowers in earlier years, though the data for borrowers entering foreclosure since 2006 show that their post-foreclosure delinquency rates have been notably higher than the historical experience and consequently, their credit scores have been recovering more slowly. Based on the historical experience, the thousands of borrowers who are currently being foreclosed (or who have been recently foreclosed) will likely experience higher levels of credit delinquency and a reduced ability to access credit for several years into the future.
For most subprime borrowers, credit scores recover to their pre-delinquency levels within a few years of the foreclosure period. Over 60 percent of subprime borrowers in the historical cohorts saw their credit scores recover within two years of the quarter in which their mortgage entered foreclosure. After eight years, about 94 percent of subprime borrowers recover.
As was suggested by the mean score changes, credit score recovery for prime borrowers is much slower. After two years, only 10 percent of prime borrowers have returned their credit scores to their pre-delinquency levels. The pace of recovery increases sharply at around six years after the foreclosure period, which is approximately the time we would expect information about the mortgage foreclosure to be removed from borrowers' credit records.11 But even after the delinquency information has been expunged, recovery appears to be incomplete for many prime borrowers. One-third of prime borrowers in our sample do not see their credit scores return to their pre-delinquency levels. This is true even for those borrowers whom we observe 10 years after their mortgage entered foreclosure.
We find that credit scores decline into the subprime range as a borrower's mortgage enters foreclosure. While scores begin to recover almost immediately, for borrowers who had prime-level credit scores prior to their mortgage delinquency, the recovery takes many years, if it comes at all. The lack of recovery appears to reflect a change in borrower behavior following foreclosure in which the borrower exhibits greater levels of delinquency on all types of consumer credit in subsequent years.
With the data available, we are unable to identify the reasons for this change in behavior. Nevertheless, there are at least three possible explanations for the patterns that we observe. First, the foreclosure process may alter a borrower's financial circumstances in a manner that makes future delinquencies more likely. Mortgage delinquency and foreclosure lower borrower credit scores, thereby reducing access to credit or increasing the costs of access. The foreclosure may also destroy wealth or deprive borrowers of a wealth-building asset, thereby reducing their ability to weather the trigger events that are associated with delinquency. In this case, the change in borrower circumstances that can explain future elevated delinquency levels is a direct effect of the foreclosure.
The final possibility is that the changes we observe are independent of borrowers' financial circumstances and, instead, represent changes in borrower preferences. Going through a foreclosure may lower the "stigma" that the borrower internalizes from the delinquency. Alternatively, having a low credit score may reduce the incentive for making on-time payments. As a result, borrowers may perceive lower costs of delinquency in the future. Unlike the previous two explanations, this possibility focuses on a change in borrower behavior that is internal to the borrower.
These possible explanations are not mutually exclusive, and each may play a role in explaining subsequent changes in borrower behavior. With the data that we have available, we are unable to directly test whether each of these play a role or, if so, the contribution that each makes to the post-foreclosure patterns that we observe. Nevertheless, the success of policy interventions designed to reduce these effects will depend critically on the extent to which each of these explanations is driving the change in behavior.
Kenneth P. Brevoort
Federal Reserve Board
Cheryl R. Cooper
Research Associate II
The Urban Institute