Foreclosure vs bankruptcy: Which is Worse?

If you have fallen behind in your mortgage payments and are facing a possible foreclosure, you might be wondering "What are the foreclosure consequences on my credit and financial health?" You may also have considered filing for bankruptcy.

Foreclosure and Bankruptcy are both legal actions that will show up in the public record portion of your credit report. Each will have a very significant impact on your credit. The effects of both bankruptcy, and foreclosure effects upon your overall financial health should be carefully considered. You also need to make a decision early on whether or not you want to keep your home.

If you're determined to keep the home, filing Chapter 13 bankruptcy makes sense. This would help you to pay off at least part of the mortgage, mainly the amount by which you're behind on the loan. The payoff timeline in Chapter 13 is quite short, typically within 3-5 years. You'll probably be required to attend credit counseling sessions prior to the date of filing bankruptcy. You'll also have to pass a means test to determine your eligibility for chapter 13. But, you'll avoid the many negative foreclosure consequences.

While there are many negative foreclosure effects, bankruptcy is still considered by many consumers to be the last resort. It can, however, clear away all outstanding debt and (in some states) preserves many important assets, including your home. It has a 10-year statute of limitation. Once you file for bankruptcy, the creditors can no longer report your debt as delinquent. And, you can rebuild credit in as little as 2 years.

Bankruptcy will cost a few thousand dollars when handled by a competent attorney. There are books available that can assist you in filing for bankruptcy without hiring a lawyer, but mistakes can be costly. Clearly, the do-it-yourself bankruptcy is not for everyone.

There is a 7 year statute of limitation on foreclosures. But you'll suffer a "double hit" to your credit score; once for the trade line and another hit for the legal entry. Having a foreclosure on your record, you will find it extremely difficult to get mortgage financing for most of the time it shows. Foreclosure is the worst indicator of risk to a mortgage lender, when evaluating you as a potential borrower for a home loan.

A bankruptcy, on the other hand, stays on your credit report for 10 years but doesn't affect your credit rating after the initial hit. Best of all, when you file bankruptcy, the court notifies creditors that they are not to take any action against you. So, you should see no further damage to your credit.

Once you qualify for filing a Chapter 13 bankruptcy, you'll need to prepare a repayment plan that pays your living expenses and other financial obligations in addition to monthly payments under Chapter 13. Then submit your plan to a court-appointed trustee who will review it and send the proposal to your lender.

The lender may challenge your proposal at a hearing if he sees the plan as unreasonable. After the plan is approved, you can go ahead with the filing. Once you file Chapter 13, the lender will stop foreclosure. Until you are discharged, the lender cannot begin foreclosure again.

An important benefit of Chapter 13 bankruptcy is that it shows you've cleared debts rather than avoid them. This makes a positive impact on your credit report compared to foreclosure. If you fail, however, to reorganize your debts and catch up on payments, the lender will probably foreclose. You'll then have both a bankruptcy and a foreclosure on your record. It's vital that you not miss any payments under the Chapter 13 plan or the court could dismiss your case. The lender is then free to foreclose on your home.

Another big plus with Chapter 13 bankruptcy is that it helps you to save your home. Even if your home is worth more than the homestead exemption of $125000 (under certain conditions), you are able to keep it. The most common foreclosure consequences are that (1) you lose the home and (2) if the house doesn't sell for more than what you owe, the lender may file a deficiency judgment (except in anti-deficiency law states). You'll then have to pay the deficiency unless the lender cancels the debt. This will be reported on your credit report and is likely to affect your credit. There are also tax issues: If you don't pay the deficiency, you may have to pay income tax on canceled debt.

Bankruptcy is an option which can help to avoid foreclosure. But when deciding between foreclosure vs bankruptcy, you should understand which option will work better in your particular situation. There is no single solution that fits every debtor's situation. The most important thing is to act quickly once you realize you can no longer meet all of your monthly financial obligations. That's the right time to talk to your lender and find a solution to your problem. You should consult with a knowledgeable attorney to discuss possible foreclosure effects on your financial well-being prior to going ahead with either action.

Still have questions? Check out Foreclosure FAQ