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Foreclosure vs. Bankruptcy: Which Does More Damage?
By Gina PogolMortgage Credit Problems Columnist
Homeowners with too
much debt and too little home equity are looking for a way out. Those whose
income isn't enough to cover the bills may be considering letting the house go
into foreclosure or filing for bankruptcy protection. Neither choice is very
appealing.
Foreclosure and Your
Next Mortgage
In the lending industry bankruptcy is considered a serious
credit issue, but foreclosure is worse. In fact, even being late with mortgage
payments is counted by mortgage underwriters as a serious infraction, worse
than a collection account or a judgment against you. Homeowners who skip their mortgage
payment to pay other bills are doing their credit serious harm. This
compromises their ability to get approved for a mortgage in the future. According
to debtworkout.com, "foreclosures
can be viewed as one of the worst things ever on a credit report. Even so, some
banks will make you a loan very soon after a foreclosure. Be prepared for very
large down payments and high interest rates. Most often the terms of these
loans prevent people from buying another house…"
Even FHA lenders won't approve a borrower with a foreclosure
for at least 3 years, while they
will give borrowers with bankruptcies loans after 2 years, and even after only
one year in exceptional cases. Once you show that you are willing to walk away
from your home to avoid your obligation, few mortgage lenders will want to put
themselves in the role of "sucker" the next time you need a loan.
Bankruptcy Can Save
Your Home and Your Credit
While lenders won't exactly greet you with open arms
following a bankruptcy, they are considerably more forgiving than if you let
your home go into foreclosure. In fact, people who paid their bills on time
right up to the day they filed for bankruptcy have walked into their lender's
office six months later with credit scores over 700 -- and they were approved
for grade A loans. Your score down the road depends on how you go about
bankruptcy. Do whatever you can to make payments on time while you consult a
bankruptcy attorney or credit counseling service. If you let your bills go for
six months and then get around to filing, your credit will take a much greater
hit.
Advantages of
Bankruptcy over Foreclosure
First, filing for bankruptcy will stop any pending
foreclosure proceedings on your home. Not forever, but it can give you a chance
to sell it or work out a resolution with your lender. Second, bankruptcy can
potentially relieve you of other monthly obligations. Foreclosure only gets rid
of your mortgage, and then you still have to find a place to live and pay for
it. So your finances might not improve all that much. And finally, in most
states your lender may be able to force you to pay what is called a
"deficiency" when your foreclosed home is sold, meaning they can hit
you up for the difference in what you owed and what they were able to get from
selling your property. If this happens you might have to file for bankruptcy protection
anyway.
When Foreclosure Is
Your Only Way Out
Bankruptcy isn't automatically granted just because you ask
for it. Filers now have to pass a "Chapter 7 Means Test," and this
test is applied to your financial situation to determine if you have the
ability to pay your debts. If your
income is higher than the median income in your state for a family the same
size as yours, and you have disposable income greater than $100 a month, you
will probably not be allowed to file under Chapter 7-- and will be forced to
pay at least some portion of your debts. If your mortgage payment is truly
insurmountable and couldn't be paid even if you discharged your other debt, and if your lender is unwilling to discuss
workout options with you, then foreclosure may be the only way. But it's a hard
way.
Both Bankruptcy and
Foreclosure Are Last Resorts
Blowing off your mortgage just because your home value has
decreased is not smart; in addition to legal fees, interest, and deficiencies,
you will probably pay a lot more for credit for a very long time. Consider that
while you remain in your home its value is not much of an issue. Real estate
markets are famous for their ability to bounce back--but you won't be in any
position to take advantage of it if you trash your credit with a foreclosure.
By letting the house go you could be forced into paying thousands out of pocket
for a temporary decrease in value; when the lender has to sell your house cheaply
and forces you to pay a deficiency, you will have turned a "paper"
loss into a real one.
The best solution is to enlist the help of your creditors,
find a reputable credit counseling service, and get your financial house in
order. You could end up saving both your finances and your house.
Sources:
Debtworkout.com
Federal
Trade Commission
About the Author
Gina Pogol writes for
an online media company and specializes in finance and mortgage issues. She
formerly worked as a systems consultant with Experian and a mortgage consultant
with Centex. She has a BS in financial management from the University of
Nevada.
About the Author
Gina Pogol works as a writer and editor for an online media company. She has a BS in financial management, was formerly a business credit systems consultant with Experian and a mortgage loan consultant.
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