Note: For legal or financial advice regarding your specific needs, please contact an attorney or financial adviser in your state.
Foreclosure and bankruptcy are usually last resorts when it comes to your finances. They both have a strong impact on your credit score and can have far- and long-reaching financial consequences.
What Happens When You Foreclose?
In brief summary, when you can’t pay your mortgage, your mortgage lender may let you try a short sale. A short sale is when a house is sold for less than the cost of the mortgage. If you can’t do a short sale or the house doesn’t sell, your lender will likely hold a foreclosure auction. If the house still doesn’t sell, your lender officially takes ownership of the property. For the homeowner, a foreclosure means that you are defaulting on the loan and are giving up ownership. However, this doesn’t mean that you are free from all financial obligations to your lender. If the house doesn’t sell in foreclosure for enough to cover the mortgage, you may still be responsible for paying the difference.
How Long Does Foreclosure Stay on Your Credit History?
A foreclosure is a serious negative mark on your credit history. It can stay on your credit report for seven years, starting from the date of the first missed payment.
Applying for a Mortgage After a Foreclosure
Applying for a mortgage after a foreclosure can be very difficult. Some lenders require you to wait a certain amount of time before you can apply for another home loan. For example, you must wait three years after a foreclosure to be eligible for an FHA loan.
If you’re ready to apply for a mortgage after a foreclosure, make sure you can afford the payment. Ideally, your mortgage payment should be less than 28% of your take-home pay.
Lenders will be looking closely at your credit history during the mortgage application process. Ray Hooper, the Education and Housing Director for the Consumer Credit Counseling Service of Greater Dallas, says, “A foreclosure is very serious to mortgage lenders. They’re going [to] look at a foreclosure more seriously than they will a bankruptcy that doesn’t include the house.”
The best scenario is if you had excellent credit before the foreclosure and have had excellent credit since. You want to be able to show the lenders that this was a one-time thing and not indicative of your overall creditworthiness.
What Happens When You Go Bankrupt?
What happens when you file for bankruptcy depends in large part on which type you are filing. But the first thing filing does is stop creditors from being able to continue to try to collect on debts. This is important because it often keeps creditors from being able to pursue actions to garnish your wages or take your assets as repayment.
In a Chapter 13 bankruptcy:
- You develop a payment plan to pay some of your debts.
- Debts are prioritized according to type, and each payment plan is slightly different depending on the type and amounts of the debts owed.
- You keep your assets, and after you make the partial agreed-upon payments through the bankruptcy period, your other included debts are forgiven.
In a Chapter 7 bankruptcy:
- Most assets are liquidated, meaning they are given back to the lender or are sold off to repay the debt.
- You don’t use a payment plan.
Note that Chapter 7 bankruptcy is often more difficult to qualify for—there is a means test you can take to see if you qualify for it.
How Long Does Bankruptcy Stay on Your Credit History?
A bankruptcy can stay on your credit report for 10 years, depending on the type. A Chapter 13 bankruptcy can stay on your credit for seven years, and a Chapter 7 bankruptcy can stay on your credit for 10 years. The Fair Credit Reporting Act (FCRA) also states that “if the debt was discharged in bankruptcy, however, a CRA [credit reporting agency] may report it for 10 years.”
Applying for a Mortgage After Bankruptcy
The process for applying for a mortgage after bankruptcy will depend on the lender and the type of bankruptcy in some cases. Non-FHA lenders usually require a waiting period of one to four years after a bankruptcy is discharged to be able to apply for a loan. It’s important to be very careful with your credit after a bankruptcy to ensure that when the time passes, you’re in good standing at that point.
FHA loans typically require you to wait a minimum of two years after a Chapter 7 bankruptcy before you can apply for a mortgage. There is no waiting period for an FHA loan after a Chapter 13 bankruptcy, but there are conditions you must meet first.
Keep in mind that even if you’re past the waiting period, your bankruptcy could still keep you from qualifying for a mortgage. Your credit score takes a serious hit with bankruptcy, and many lenders may disqualify you on that factor alone.
Which Is Worse—Foreclosure or Bankruptcy?
When it comes to comparing foreclosing or filing for bankruptcy, which is worse really depends on your individual circumstances. Neither are great for your credit, and both come with serious financial consequences.
Foreclosure may be worse than filing for bankruptcy in some cases because it shows potential future lenders that you are willing to walk away from debt obligations. If you were to file for a Chapter 13 bankruptcy that lets you restructure your finances and continue making payments on debt, you may be able to show future lenders that even when the situation was dire, you still tried to pay your debts as best you could.
In situations where your mortgage is the problem and you’re able to handle the rest of your debt obligations, a foreclosure might be the better option. Defaulting on one debt instead of several might be better for your credit in the long term.
Facing Financial Emergencies
Whether you’re in a position where bankruptcy is your only option or you’re just starting to feel your budget tightening and wondering how you’re going to make everything work, facing a financial emergency is stressful. Here are a few tips to help you weather the storm and make informed decisions during this trying time:
- Notify your lenders as soon as possible. It may seem counterintuitive to let your lenders know you might have trouble paying your bills, but the sooner you take action, the better. Whether it’s lowering your monthly payment, lowering your interest rate or setting you up on a payment plan, many lenders and even other companies—like utility providers—have programs in place to help people who are struggling.
- Double-check the budget. See if there’s anything else expendable that can go or can be cut back. Shop around for insurance rates and check your statements for recurring subscription charges you aren’t still using. You may also want to see if you can get a side job during this time to add a little more income.
Bankruptcies and foreclosures are serious negative items on your credit report, but going through either of these doesn’t mean that all is lost. For questions regarding foreclosure or bankruptcy, please contact an attorney licensed in your state who works on these matters on a routine basis.
For more information on how you can rebuild your credit, potentially remove negative, inaccurate items from your credit reports and get back on the path to financial success, contact Lexington Law and get started with a free credit report consultation.