Foreclosure or Bankruptcy, What’s Worse?

An overview of foreclosure, bankruptcy, and their consequences.

Laura Adams, MBA
4-minute read
Episode #95

Foreclosure Consequences

Not only does foreclosure remain on a credit report for up to seven years, but it can trigger some nasty tax consequences. This happens when the sale proceeds at auction or from a short sale are less than what’s owed on the delinquent loan. The difference is considered taxable income in certain situations. And when the sale doesn’t cover the full debt, in many states the lender can file a deficiency judgment and sue the borrower for their loss. All these bad consequences to foreclosure may leave you thinking that bankruptcy would be a better option…

Personal Bankruptcy Options

Bankruptcy is a legal process that’s completely separate from foreclosure. There are strict requirements to qualify for financial relief under any type of bankruptcy. Filing is a complex process that costs money and usually requires the guidance of a specialized attorney. The most common types of bankruptcy for individuals are Chapter 7 and Chapter 13.

Chapter 7 involves liquidation, which means that a court-appointed trustee takes over your non-exempt possessions to sell them or give them to creditors. This discharges unsecured debt but does not erase things like judgements, tax bills, child support, or secured debts such as home loans. So Chapter 7 bankruptcy will not stop a foreclosure sale. It is the best option for people with little property but a lot of unsecured debt such as credit cards or medical bills. Chapter 7 stays on a credit report for ten years.

A Chapter 13 filing is known as a wage earner’s plan or a debt adjustment bankruptcy. It requires a regular source of income to pay debts over time to a trustee following a court-approved repayment plan. This delays and reduces payments to all creditors, including home lenders. So Chapter 13 can stop foreclosure as long as the agreed upon payment plan is honored. It will stay on a credit report for seven years.

Which is Worse?

There’s no simple answer for which option is best… or should I say the least worst? To choose between foreclosure and bankruptcy is like choosing between a root canal and open heart surgery! They’re both going to be uncomfortable, but are options of last resort to put a debtor on the road to financial recovery.

If you’re a homeowner in default on your home loan, you’ll first need to decide whether you want to try to keep your home. If you do, communicate with your lender as early as possible about every option they’re willing to consider. But if reducing your monthly payment, or even eliminating it all together through foreclosure or a short sale, would still leave you in a dire financial condition, consider discussing your eligibility for bankruptcy with an attorney and a qualified credit counselor.

For information about mortgage short sales, check out this previous episode of Money Girl.


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Additional Resource:

More Bankruptcy Information

Bankruptcy Form image courtesy of Shutterstock


About the Author

Laura Adams, MBA

Laura Adams received an MBA from the University of Florida. She's an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura's previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.