Your worst credit problems are not as bad as you think

There's a cruel irony to navigating your finances amid the ongoing credit crunch.

On the one hand, maintaining a great credit rating is more important than ever – especially if you're looking for a job or need a loan of any kind. On the other hand, if you mess up royally in the credit department, rest assured that even the worst credit mistakes you can make probably aren't as bad as you fear.

Here's a look at a couple of the most severe credit catastrophes you can face – and why none of them is fatal to your financial life.

Bankruptcy

Bankruptcy is often described as the mother of all credit problems, and for good reason. A bankruptcy filing has very serious ramifications for your credit rating and typically stays on your credit files for 10 years.

But that doesn't mean you're a financial pariah for a decade. In reality, if you go through a Chapter 7 bankruptcy (where most of your consumer debts are wiped out), you'll likely be getting credit card offers and other loan solicitations just six to 12 months after your bankruptcy is discharged.


In fact, you can even get a government-backed FHA mortgage while you're still in a Chapter 13 bankruptcy, where you repay some of your debts over three to five years.

FHA loans are permitted one year after a Chapter 13 filing, as long as you can come up with a down payment and have made 12 on-time payments to the bankruptcy trustee.

Foreclosure, Deed in Lieu of Foreclosure or Short Sale

There's a common misconception that doing a short-sale (in which you sell a home for less than the mortgage and the bank accepts the discounted price), or a deed in lieu of foreclosure (where you turn over your house keys and work with your bank instead of just walking away from a home) is somehow better for your credit than a full-blown foreclosure. That myth is simply untrue.

According to Fair Isaac Corp., which creates FICO credit scores, all these accounts are treated equally (i.e. negatively).

Fair Isaac's myfico.com website states: "The common alternatives to foreclosure, such as short sales and deeds-in-lieu of foreclosure are all noted as 'not paid as agreed' accounts and considered the same by your FICO score."

When it comes to buying another home in the future, however, a short sale or deed in lieu does give you the option to rebound faster and buy another home in the future more quickly.

Until recently, anyone with any kind of foreclosure on his or her credit report was essentially locked out of the housing market for five years. That's because lenders would see the foreclosure (or the short sale/deed in lieu) and refuse to do a loan because they knew such as loan was not eligible to be sold to Fannie Mae or Freddie Mac.

But in late April, Fannie Mae announced it was relaxing its rules toward people who went through short sales or deeds in lieu of foreclosure. Fannie Mae now says that starting in July these borrowers can be eligible for a government-insured loan in just two years, compared with the previous "lock out" period of four years.

So here's the overall lesson: Yes, it's vital to maintain a healthy credit rating. But if you stumble along the way, or suffer major blows to your credit, all is not lost.

In certain ways, the credit-scoring universe – and the financial services world that relies on it – is sometimes a tad bit more forgiving than you might think.

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