Foreclosure or Bankruptcy: Which Does More Damage?
Mortgage 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.
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