Bankruptcy and foreclosure can each have serious negative consequences for your credit scores. But what if you experience one and then the other? Is it a double-whammy?
Our reader Brent went through bankruptcy nearly seven years ago, and did not reaffirm his mortgage. But he continued to make his mortgage payments, and is still living there. (When you do not reaffirm your mortgage in bankruptcy you can continue to live in your home as long as you make your payments. But you are no longer personally liable for the debt if you decide to leave.)
Now Brent is thinking about walking away from his home.
"I am NOT in any danger of a foreclosure," he wrote. "My handing the house back over to the mortgage company would be strictly voluntary. The reason I'm pondering doing so is the housing market where I live is still pretty depressed, houses sit on the market 6 months to a year and if I do sell chances are it would end up being a short sale. So what are the consequences of handing the house back over to the Mortgage Company after the debt has been discharged under chapter 7 of Bankruptcy court?"
Brent is right to be concerned. If he walks away the lender will have to take steps to regain possession of the home so it can dispose of it. That is usually accomplished through a deed-in-lieu of foreclosure, a foreclosure or a short sale.
If a foreclosure or other negative information about his mortgage were to be reported now — years after his bankruptcy — it could extend the time that it takes him to rebuild credit and might even affect how soon he can get another mortgage. (More on that in a moment.)
But Brent, and others in his situation, may be in luck. Letting the house go should not further impact a consumer's credit scores if they did not reaffirm their home loans, says Robert Weed, a Northern Virginia bankruptcy attorney. "Their credit reports should show bankruptcy and nothing since then. Nothing if you pay and nothing if you don't pay," he says. That's because when these homeowners did not reaffirm their home loans, he explains, "it stopped being a debt when you filed for bankruptcy."
Furthermore, Weed believes a bankruptcy is better than a foreclosure. That's because when your bankruptcy is done you don't owe the money anymore, but with foreclosure you may still be sued — in most states — for a deficiency. That's one reason why consumers who can't afford to pay their mortgages should at least explore their options with a consumer bankruptcy attorney.
Of course there is the possibility that information will be reported incorrectly, in which case the consumer will have to dispute the mistakes on their credit reports.
On the flip side, we've heard from consumers who are frustrated that their mortgages do not appear on their credit reports after bankruptcy because they did not reaffirm them. But the benefit of having your mortgage reporting on your credit reports may be outweighed by the risk that you take by agreeing to continue to be personally responsible for the loan. If you can't pay the loan in the future, you could wind up in foreclosure — or even in bankruptcy again. Again, this is a discussion you'll want to have with an attorney.
What if Brent wants to buy a house? Will the fact that the home goes into foreclosure in the near future push the date he can finance another home off a few more years? That used to be the case, says Weed. Lenders often follow Fannie Mae guidelines which specify the time period that must elapse between a foreclosure and a new loan, and it used to be that date was measured by the date of the foreclosure. But last year, Fannie Mae clarified that if there was both a bankruptcy and a foreclosure on the same property, the bankruptcy time period may be used. The guidelines say:
If a mortgage debt was discharged through a bankruptcy, the bankruptcy waiting periods may be applied if the lender obtains the appropriate documentation to verify that the mortgage obligation was discharged in the bankruptcy. Otherwise, the greater of the applicable bankruptcy or foreclosure waiting periods must be applied.
After Bankruptcy or Foreclosure
Anyone who goes through a serious credit crisis that leads to bankruptcy or foreclosure needs to start the process of repairing their credit as soon as the crisis has passed. The sooner you start, the sooner you'll see progress. Here is a helpful guide to rebuilding credit. Review your credit reports on an annual basis, at a minimum. You can monitor your progress by tracking your credit scores for free on a monthly basis at Credit.com.
"What you want to do is to work really hard to get back to good credit," says Weed. Consumers who have been proactive on that front will have greater options. "You can can look around and ask what kind of house can I afford and how does that compare to the deal I'm in?" he says.
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