Which is right for you - bankruptcy or foreclosure?

When you are to decide between a foreclosure and bankruptcy, the first thing to ask yourself is whether you'd like to keep the home. If you're keen on keeping the home, filing chapter 13 makes sense. This helps you to pay off all or part of the mortgage, specially the amount by which you're behind on the loan. And this is done within a short period of 3-5 years. However, before you file bankruptcy, you'll have to go through credit counseling session within 6 months prior to the date of filing and then pass through the Means Test which confirms whether you're eligible for chapter 13.

Once you qualify, prepare a repayment plan such that you'll be able to pay daily expenses and other financial obligations apart from making monthly payments under Chapter 13. Submit your plan to a court-appointed trustee who reviews it and sends the proposal to the lender.

The lender has the right to challenge the proposal at a hearing if he feels the plan is unreasonable. Once the plan is approved, you can go ahead with the filing and as soon as you file Chapter 13 , the lender stops foreclosure. And until and unless you are discharged, the lender cannot initiate foreclosure again.

However, the question of foreclosing at the end of the 3-5 year period doesn't arise if you have cleared the dues and are able to continue with the outstanding balance. You can even refinance or sell the home after that and get rid of the remaining balance.

What's important is chapter 13 shows you've tried to clear debts instead of avoiding them and this creates a positive impact on your credit report compared to foreclosure. However, if you fail to reorganize your debts and catch up with the payments, the bank is likely to foreclose and then you'll have both bankruptcy and foreclosure on your credit, which is again very disturbing for any debtor. So, you shouldn't miss any payment under the Chapter 13 plan or else the court will dismiss your case and then you'll have no option but to lose your home in foreclosure.

Another positive aspect about chapter 13 is, it helps you keep the home. So, even if your home is worth more than the homestead exemption of $125000 (under certain conditions), you need not worry as you are able to preserve it. But when you foreclose, you lose the home and added to it, if the house doesn't sell for enough, the lender may file a deficiency judgment (if it's not an anti-deficiency law state). And then you'll have to pay the deficiency unless the lender/mortgage company cancels the debt. However, this will be reported on your credit report and is likely to affect your credit.

Then there are tax issues involved with the deficiency. If you don't pay the deficiency, you'll may have to pay tax on canceled debt unless your property is in California or you don't satisfy the criteria for mortgage debt forgiveness.

Once the bankruptcy starts, the creditor/lender can no longer report your debt as delinquent. So what affects your credit is the bk and no other debt. But you can rebuild in 2 years. However, in other situations, the bank won't even start negotiating until you are 2-3 months behind and by that time your credit already gets the hit. And then if you add a foreclosure, it turns out to be a 7 year record with your credit way below the average.

The bankruptcy on the other hand, stays on your report for 10 years but it doesn't affect your credit rating after the initial hit. The best thing is, when you file bankruptcy, the court sends a note to your creditors/lender preventing any activity against you. So, you can expect no further credit damage. As for the credit report, it's better to have a 650 score with bankruptcy instead of a 480 score and no bankruptcy.

Bankruptcy is no doubt one of the options to stop foreclosure. But there's no one solution that fits every debtor's situation. So, the best thing is to act when you realize you cannot afford any longer. That's the right time to talk to your lender and find out a solution to your problem.