According to the Mortgage Bankers Association the number of Americans late on their monthly mortgage payments has steadily risen over the course of the recession and shows no immediate sign of slowing. Nearly 9.7% of all American mortgage holders, or 4.5 million homeowners, were delinquent (at least one payment past due) on their loans and if you add in homeowners already in the foreclosure process that number jumps to 14.41% - the highest ever recorded by the MBA.
Often, distressed homeowners are faced with two undesirable options: foreclosure or bankruptcy. Although consumer bankruptcy filings fell by 18% in November, American Bankruptcy Institute (ABI) Executive Director Samuel Gerdano reports that "consumers are still feeling the effects of rising unemployment rates and housing debt."
The ABI forecasts that personal bankruptcy filings will have topped 1.4 million by the end of 2009. If you are a distressed homeowner, you may be wondering: should I consider filing for bankruptcy to avoid foreclosure?
The Short Answer
The bottom line is that neither option - bankruptcy or foreclosure - is great. However, it is important to know the differences between the two. A bankruptcy will most likely enable you to keep your home and wipe out most of your other (qualifying) debt but it will remain on your credit report for 10 years and cause your credit score to plummet by as much as 400 points. (We walk through the steps needed to secure the best loan to finance the purchase of your home. Don't miss Understanding Your Mortgage.)
On the other hand, under foreclosure you lose your home, which is, well, awful. But the action will only stay on your credit report for seven years and your credit score is likely to suffer less than with a bankruptcy filing. However, lenders may weigh a foreclosure more heavily as a factor in future loan decision-making than a bankruptcy. The short answer is that there is no one, short, easy answer - there are only options which you need to carefully examine before making a decision.
How It Works
There are two main types of personal bankruptcy - Chapter 7 and Chapter 13. Chapter 7 bankruptcy allows you to "discharge" (or clear) all qualified debts - such as unsecured credit card debt - within a short period of time.
In most states you would be able to keep your home under a Chapter 7 bankruptcy. But it's critical to know your state's bankruptcy law because there may be factors such as the length of time you have owned your home, or how much equity you have already built up in your home, that can affect whether or not your home will be considered a sheltered asset.
Alternately, under a Chapter 13 bankruptcy your debts are not immediately eliminated. Instead the court will approve a restructured debt repayment program. You will have to agree to repay a portion of all qualifying debts over a specified period of time (typically 3-5 years); afterward, most of the remainder of your debt is often forgiven. With a Chapter 13 bankruptcy you will have to work with your mortgage lender or servicer to catch up on your late mortgage payments in order to stay current and avoid foreclosure.
The major foreclosure-related benefit of filing for either form of bankruptcy is that the court will issue an "automatic stay." The automatic stay prevents all creditors - including your mortgage holder - from continuing any procedures to collect money from you, including your monthly mortgage payment. If your home is already in the foreclosure process - meaning that the bank has begun taking action to repossess their property (your home) - the bank, lender or servicer that holds your loan cannot continue any actions against you.
For example, any scheduled foreclosure sale must be postponed. Typically the stay will prevent any additional action from being taken to foreclose on your home, and can give you up to an additional 3-4 months to work something out so that you can stay in the home or sell the home and avoid foreclosure. It's important to note, however, that if your lender files a motion to "lift the stay" you may have less time.
Not An Automatic Guarantee
Filing for bankruptcy can give you more time by temporarily suspending foreclosure proceedings but it does not automatically mean that you will be able to keep your home. If your home is protected and you have not defaulted on your mortgage, you will need to continue making your payments on time and in full. However, if you are already in default - behind on your mortgage - you will have to work out arrangements with the mortgage company to both repay your past due mortgage payments and stay current on the loan going forward.
It is critical that you be able to make your monthly mortgage payments because if you are even one day late in getting your payment to your mortgage lender or servicer the court can lift the stay and foreclosure proceedings would be allowed to resume.
Before You File
It's important to do everything you can to avoid falling into the foreclosure process before having to make this decision. Gather all your necessary documentation and contact your lender as soon as possible to let them know about your financial situation and to request a modified mortgage workout.
Your lender may provide temporary forbearance during which time you can make only partial payments or not have to pay at all, followed by a period of time during which you pay an additional amount on top of your regular monthly mortgage payment to catch up on your past due amount.
Your lender could also make the modification permanent by adding your missed payment amounts to your principal and then re-amortizing the loan; you could even qualify to have the interest rate lowered. If you really cannot afford the mortgage even after a temporary modification, your lender may provide forbearance to give you time to sell your home. Another option would be a deed in lieu of foreclosure. However, once your home goes into foreclosure your options become more limited.
Remember, before you file for bankruptcy as a means to save your home:
- Make paying your mortgage your financial priority and make your payments on time and in full if possible.
- Contact your lender to discuss your financial situation and options.
- Update - or create - your personal budget.
- Work with a well-established, reputable credit counseling agency to learn more about your options before taking action.
- Calculate all of the bankruptcy-related costs including attorney's fees, the potential loss of personal property, savings and investments, etc. to know how much it's going to cost you out-of-pocket.
- Work with an experienced, credible bankruptcy lawyer that knows the bankruptcy laws in your state.
- Realize that you will have to abide by your debt repayment plan (if you are filing for Chapter 13 bankruptcy) or be at risk of foreclosure again.
The Bottom Line
Filing for bankruptcy or foreclosure is not a pleasant process. Make it as easy on yourself as possible by being informed and knowing all your options. (Hidden costs can create what looks like a good deal. Find out how to find the best mortgage possible in Score A Cheap Mortgage.)