I am often asked by my clients who are facing foreclosure how credit score is affected by foreclosure and if a short sale, deed-in-lieu of foreclosure or filing bankruptcy is a better option with regard to the effect on their credit score. First one must keep in mind that there are other issues to consider in addition to how the foreclosure will affect your credit score such as tax consequences from the foreclosure and other factors outside of your credit score that lenders will look at in order to provide you with loans and financing in the future.
From a practical standpoint, the effect on your credit score resulting from a short sale, foreclosure or bankruptcy, are ultimately very similar. According to Fair Isaac (also known as FICO), your credit score when facing a short sale, foreclosure or deed-in-lieu of foreclosure will drop anywhere from 85 to 160 points. Should you file bankruptcy, your credit score will drop anywhere from 130 to 240 points. If one were just to make a decision based upon the drop in one’s credit score, you would reach the conclusion that a foreclosure is better than a bankruptcy. However, when one considers other factors such a conclusion is wrong.
There are two main reasons why a bankruptcy can be preferable to allowing a home to go to foreclosure. First, when a property goes to foreclosure, the debtor still faces the possibility of the lender pursuing the debtor for a deficiency, which is the difference between the fair market value at the time the property is sold at public sale, and what is owed on the mortgage. For example, if the debt is $200,000 on a mortgage and the property is only worth $150,000, the borrower will face a $50,000 deficiency judgment (not including attorney fees, court costs and interest). The bank can then hold this Judgment for 20 years or start collection proceedings against the debtor which may include a wage garnishment. Banks are now more actively pursuing these deficiencies. However, if the debtor were to file for bankruptcy, this $50,000 would be discharged or wiped out and the lender could not go after the borrower for any money. In addition, there is no tax consequence for the forgiveness of this debt through bankruptcy.
A second reason why bankruptcy or a short sale is better than allowing a foreclosure to proceed to judgment and sale, is that the debtor will be able to more quickly qualify for a mortgage in the future. This is because while each bank has its own guidelines, most banks generally follow the guidelines set forth by Fannie Mae and Freddy Mac. The guidelines are very lengthy, but they can be summarized as follows:
1. Under the guidelines, your best option for purposes of obtaining a new loan in the future is to either do a deed-in-lieu of foreclosure (where you transfer the property back to the lender in exchange for a release of any deficiency) or a short sale, where you sell the property for less than what is owed on the mortgage. Under the guidelines, if you have a 20% down payment, you should be able to qualify for a loan 2 years after a transfer by a deed in lieu or short sale. If you are only putting down 10%, you would qualify for a loan after 4 years.
2. Should you file bankruptcy, under the guidelines, you would qualify for a mortgage after 4 years from the date of Discharge. In a Chapter 7, the discharge occurs approximately 6 months after you file and in a Chapter 13, the discharge can come between 36 and 60 months after you file.
3. The worst option is foreclosure under the guidelines. You would have to wait 7 years from the date the foreclosure judgment was entered before you qualify for a loan under the guidelines. Additionally, if a deficiency judgment was entered against you during that time, the deficiency judgment would also have to be paid off prior to you being able to close. Obviously for these reasons, the worst case scenario should you wish to get a fresh start is a foreclosure.
In Conclusion, although from a pure credit score, a bankruptcy may cause a larger initial drop in your score than a foreclosure, in the long run, the Discharge provided by bankruptcy, especially a Chapter 7, may be a quicker and more efficient way to get a fresh start and have the opportunity buy a new home in the future. Keep in mind that the foregoing is just meant as a general discussion of these issues and each person’s situation is different. That is why it is important to always consult with qualified professionals regarding your specific situation.
Also depending on circumstances, some people may qualify sooner for credit or mortgage under the above scenarios while others may take longer. If you, a client, friend or family member are facing foreclosure or other financial issues, please contact me for a free consultation so that I can analyze your position and point you in the right direction.
Anthony J. Vignier is an experienced bankruptcy lawyer who gets results for his clients. He can give you guidance for a better financial future. Anthony has over 21 years of legal experience. He is the attorney you want on your side. Anthony considers the situation of all his prospective clients by meeting with them and going over their unique circumstances. After a Bankruptcy is successfully concluded the client receives a Discharge Order that legally removes the obligation to pay back any Debt that was discharged through bankruptcy. Anthony’s clients are able to start fresh after receiving their Discharge. Anthony’s can be reached at (800) 707-5252. His Office is located at 115 Kearny Avenue, Kearny, New Jersey.
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