Based on our mail, the financial squeeze that’s left millions of Americans falling behind on their mortgage payments doesn’t seem to be letting up. For some, that presents a stark choice: is it better to lose your house to foreclosure or file for bankruptcy protection?
What is better on your credit report - foreclosure or bankruptcy?
-- D.F., Address withheld
Neither option is going to be easy. Generally, a foreclosure will remain on your credit report for 7 years, while a bankruptcy remains for 10 years. But that doesn’t mean foreclosure is necessarily the better option, according to Ray Hooper, Education and Housing Director for the Consumer Credit Counseling Service of Greater Dallas, a non-profit agency that tries to help people facing foreclosure keep their homes.
“A foreclosure is very serious to mortgage lenders,” said Hooper. “They’re going look at a foreclosure more seriously than they will a bankruptcy that doesn’t include the house.”
Before you accept that foreclosure is a foregone conclusion, consider trying to avoid it. If you’re having trouble making payments, or even behind by a month or two, contact your lender before the process goes any further. Even if you’ve gotten an official “notice of default,” saying you’re several months behind, you still have time before the formal foreclosure process begins.
The first question you need to decide is whether you want to keep your house or give it up. If you want to keep it, you need to try to work out a plan to get back on track. This involves either making up for the missed payments – which you can do all at once or try to spread out – or coming up with a new plan. One option is to have the loan modified – at a lower interest rate, for example. Or you can ask for “forbearance,” which basically means the lender suspends payments until you can get back on your feet. If you’re in over your head and bought too much house, though, these options probably aren’t going to help.
So you may have to consider moving. Even if you do lose your house, you don’t want a foreclosure on your record when you go looking for a smaller house or a place to rent. One option is to ask the lender to hold off on foreclosing until you sell. If your mortgage is bigger than your house is worth, your looking at what’s called a “short sale” and you’ll owe money to the lender even after the house is sold. In some cases, lenders will let you off the hook for that amount rather than go through the expense of foreclosing. (But you may not be completely off the hook: you may owe taxes on that amount.)
You can also try something called a “deed in lieu of foreclosure” – which basically means you turn over your house to the lender and walk away without owing anything. But you’ll need to work this out with the lender: you can’t just leave the keys in the mailbox.
While it’s possible to work out one of these solutions with your lender on your own, you may have better luck with the help of someone who specializes in the process. A good attorney who knows real estate law can help, but you may not be able to afford that. A credit counselor (from an accredited, non-profit agency, not the slime balls who spam you with bogus promises of making your debts “go away”) is another option. Lenders are more likely to go along if a competent third party is there to help smooth the process.
If all else fails, you may have to consider allowing foreclosure to proceed – or filing for bankruptcy. But like most aspect of personal finance, there’s no “one-size-fits-all” guidelines for which is the least bad alternative. There are different ways to file for bankruptcy, and not all of your debts have to be included (for more, see the next page.) So even if faced with bankruptcy, you’ll need advice from someone - either a good credit counselor or a bankruptcy attorney - who can walk you through the choices you’ll face.
How many years apart can you file bankruptcy in Georgia?
--D.D., Address withheld
While it’s not an easy option, bankruptcy is becoming more common. Some 391,000 individuals turned to the bankruptcy courts for help getting out from under debt during the first half of this year, according to the American Bankruptcy Institute. That's up nearly 50 percent from the first half of 2006. While that’s down from levels seen before changes in the law in 2005 made it harder to file, the ABI said the number of filings is expected to continue to increase.
“Continued pressure on housing markets, combined with high consumer debt burdens, will lead more households to consider bankruptcy as an option to their financial problems,” the group said in a recent press release.
While the bankruptcy process in the U.S. is governed by federal laws and handled by a system of federal bankruptcy courts, state laws regarding consumer debts and the disposition of property also come into play. There are also different types of bankruptcy filings. No matter which course you take, the filing stays on your credit record for 10 years. That makes it very difficult to get any type of loan during that period; the loan will be more expensive if you can get one.
The two most common forms of personal bankruptcy are called Chapter 7 and Chapter 11. (About 60 percent of those who file for bankruptcy use Chapter 7, most of the rest use Chapter 13.) Under a Chapter 7 filling, you get to keep certain property (this is where state laws vary), but the rest is turned over to a court-appointed trustee who sells your stuff or gives it to lenders to satisfy your debts. Under a Chapter 13 filing, you pay back your debts under a plan worked out by the court. The trustee collects payments, pays off your debts and makes sure you stick to the plan.
If you own a business, you may want to consider a Chapter 11 filing. This let’s you stay in business, as long as the court and the people you owe money to approve of the plan to pay off your debts. If the court decides a trustee needs to be appointed, the trustee takes control of your business and its assets.
Not all debts can be wiped clean – even if you ask for a “discharge.” The list includes alimony and child support, taxes, court fines and most student loans. New debts, taken on after the discharge, aren’t included. And if the judge finds out you’ve lied or committed fraud, your discharge can be denied.
You can also choose which debts you want to have discharged while you keep paying off others. You might want to work out a payment plan so you can keep your car, for example. To do this, you have to sign a “reaffirmation agreement,” which says that you promise to pay off that debt. If you don’t pay it back, the creditor can send it to a collection agency like any other debt.
If you’ve filed a Chapter 7 bankruptcy and gotten a discharge, you’ve got to wait 8 years before you can do it again. There are different limits on filing for Chapter 13, depending on whether you’re trying to get debts discharged.
Whatever you decide to do, you’ll probably want some help. (You can do this alone, but we don't recommend it. Start with a good credit counselor or bankruptcy attorney. Get references, ask lots of questions, and don’t sign anything until you’re sure you understand fully what it says.
For more on the process, check out the Department of Justice Web sites here and here.