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Posted by: Walter Metzen
Many consumers are confused by the interplay between the two. When you file bankruptcy and surrender a home, you give the property back to the lender. When a lender forecloses on your home due to non-payment, they take the home from you.
The primary difference between surrendering a home and foreclosure is the possibility of owing money after the sale. When a home is surrendered, a foreclosure will ensue — but only as a means of clearing title so the bank can sell the home. In a foreclosure that takes place outside the context of a surrender, the borrower can end up owing the difference between the mortgage amount and the sale price the home fetches at the foreclosure sale.
This post will discuss more of the differences between voluntary surrender of a home to a lender and letting a house go into foreclosure, what happens when you file for bankruptcy instead of opting for foreclosure, and how long either a foreclosure or bankruptcy discharge will stay on your credit report.
How can my home be taken from me?
Although there are peculiarities based on state law, the basic idea behind a mortgage is fairly consistent nationwide. Mortgages are security agreements whereby the collateral for the loan (your home) can be taken by your lender in the event payments are not made.
When you sign loan documents to finance the purchase of your home, you agree that your lender can take your home from you in the event you do not comply with the terms of the loan — the most important of which is making monthly payments of principal and interest. If you fall behind on your mortgage, your lender forecloses pursuant to your agreement and becomes the new owner of your house.
But what happens if you file for bankruptcy? The big benefit of Chapter 7 or Chapter 13 bankruptcy, other than typically having to pay back your debts for pennies on the dollar, is that it activates the automatic stay as soon as you file. The automatic stay puts an immediate stop to collectors, including any collection lawsuits, wage garnishments, and foreclosure. However, you may surrender your home during bankruptcy to pay back your debts, depending on your state’s exemption laws and how much equity you have in your home.
Foreclosure vs. Bankruptcy: To Clear or Not Clear Debts
It is important to understand that your lender will be required to foreclose on your home in order to clear title from your name — even if you have surrendered it through bankruptcy. Your property will be sold at auction and in order for your lender to convey good title to a third-party purchaser, they must acquire the title themselves first. Your credit report also will likely reflect the foreclosure.
The fact that a foreclosure will take place even after a home has been surrendered is where the similarities end between surrender and foreclosure. Surrendering a home in bankruptcy extinguishes your liability on the loan. You throw the keys back to your lender and you’re done. Your lender cannot come after you personally for what once was a full recourse loan.
By contrast, in a foreclosure setting, your lender will take your home and sell it to the highest bidder. If the sale price is enough to satisfy the outstanding balance owed on the mortgage, you will not owe money after foreclosure (be careful as some loan documents call for borrowers to pay lender attorney fees associated with the foreclosure). If your home sells for less than what is owed on the mortgage, you will owe the difference.
In some cases, post-foreclosure, your lender will sue for the shortfall in an attempt to establish a deficiency judgment. Once judgment has been entered, your lender can then attempt to come after your non-exempt assets in satisfaction of the debt.
See also: Is a Short Sale Better than Foreclosure?
How will foreclosure or bankruptcy affect my credit score?
A bankruptcy will stay on your credit report for 10 years, however, bankruptcies don’t have their own section on your credit report. A foreclosure will stay on your credit report for seven years. Don’t let the difference of three years fool you, though. Mortgage lenders take foreclosure records seriously, and some credit counselors believe a foreclosure on your credit report looks even worse than a bankruptcy. If you’ve already had a tax lien or judgment on your public record, a bankruptcy also won’t affect your credit much further.
A foreclosure or short sale will typically reduce your credit score between 85 and 160 points, while a bankruptcy may knock it down between 130-240 points. However, bankruptcy can begin to look attractive depending on the accumulation of debt. Missed payments alone can drop a credit score 75 points.
Whether you choose not to fight a foreclosure or you file for bankruptcy is up to you. Everyone’s financial situation is different — that’s where an experienced bankruptcy attorney can help review your debt solutions. Our member attorneys have hundreds of years of combined experience. Contact us today for a free bankruptcy evaluation to determine if bankruptcy may be right for you.
For more information about bankruptcy and foreclosure, check out our recent blog posts:
- Bankruptcy and Foreclosure: A Consumer’s Overview
- How Long Does Foreclosure Take?
- Will a Chapter 13 Plan Look Better on My Credit Report than Chapter 7?
- How Bankruptcy and Debt Solutions Impact Your Credit Score
- Can I File Bankruptcy Without My Spouse?
Walter Metzen is a Board Certified Specialist in Consumer Bankruptcy with over 28 years of experience. He’s represented more than 20,000 bankruptcy clients in and around Detroit where his firm is located. View his profile here.