What’s worse, bankruptcy or foreclosure? It depends.

• Bankruptcy can cause a larger drop in your credit score.
• Chapter 7 bankruptcy remains on your credit report for 10 years, while Chapter 13 and foreclosures are reported for seven years.
• However, mortgage lenders generally view foreclosure as worse than bankruptcy.

In addition, your credit rating before the event and your debt management following the event affect how much your credit rating will fall and how quickly you recover.

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What’s Worse: Foreclosure or Bankruptcy?

How Much Do Bankruptcy and Foreclosure Harm Your Credit Score?

According to FICO, they both do a lot of damage. But the extent of the damage depends on your score before bankruptcy or foreclosure.

• If your score prior to bankruptcy is a respectable 680, filing will drop it on average 130 to 150 points to the 530-550 range. But if your credit score is an excellent 780, it will plunge an average of 220 to 240 points down to 540-560.
• If your credit score before foreclosure is 680, it will fall, on average, 85 to 105 points into the 575-595 tier. And if you start at 780, expect it to plummet by 140-160 points into the 640-660 range.

So the short answer is that bankruptcy does more damage. But keep reading because the short answer doesn’t apply to most people seeking a mortgage.

What Affects Credit Damage From Bankruptcy or Foreclosure?

The main damage to your credit score from either bankruptcy or foreclosure might not be the actual event. It is likely caused by the slew of missed payments, collections, charge-offs, and worse that occur in the weeks or months before the event. Consider that if your credit score is 780, a single late payment can drop your score by 100 points. (It does slightly less damage to people with lower credit scores.)

I have had mortgage clients with bankruptcies less than six months and FICO scores over 700. They had very high scores prior to the bankruptcies and no missed payments. They reaffirmed most of their debts, meaning they kept these accounts open and continued to make their payments.

But that’s not most people.

When you stop making your mortgage payments, the loan servicer (which collects payments for the lender) reports your delinquency to the credit reporting agencies as a 30-day late payment, then a 60-day late payment,  then 90 days late, until your lender finally forecloses or you give it a deed in lieu of foreclosure.

According to FICO, your first 30-day late payment drops your credit score 50 to 100 points. Each subsequent late payment hurts your credit score even more.

Similarly, people generally file for bankruptcy protection as a last resort — after being several months past due on their payments and maybe even acquiring a collection or two.

Chapter 13 vs. Chapter 7 vs. Foreclosure

Finally, the type of bankruptcy matters. Chapter 7 bankruptcy is simple and wipes out all eligible debts. But it stays on your credit report ten years after filing. Chapter 13, on the other hand, requires you to make monthly payments into a reorganization plan, usually for five years. Most lenders consider applicants who file Chapter 13 bankruptcy in a more favorable light because they pay back at least some of what they owe.

Mortgage foreclosure hurts you more with mortgage lenders because they weigh mortgage debt more highly than they do other debts. If you burn your credit card companies but continue to pay your mortgage, your credit rating could take less of a hit than it would if you blew off your mortgage for six months before the lender finally took your house.

Take Quick Action

The point of the last few paragraphs is that, if you’re struggling financially, it’s best to contact a reputable, non-profit, credit counselor before you start missing payments. They can analyze your debts, help you budget, perhaps get your payments and interest rates reduced, and put you on the path to financial recovery.

But if it becomes obvious after they look at what you earn and what you owe that you can’t afford your payments, or that you won’t clear your unsecured debts within five years even with a debt management plan (DMP), you should strongly consider bankruptcy (and possibly foreclosure — ask your lawyer).

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How to Get a Mortgage After Bankruptcy or Foreclosure

The waiting period for a mortgage after bankruptcy or foreclosure depends on several variables. If your bankruptcy or foreclosure was your fault (and not due to extenuating circumstances like a catastrophic illness or death of the wage earner) shortest waiting periods apply for FHA home loans. They are:

• Chapter 7 bankruptcy: 2 years from the discharge date
• Chapter 13 bankruptcy: 12 months of on-time payments into the plan and approval from the bankruptcy trustee
• Foreclosure or deed in lieu of foreclosure: 3 years

If you are eligible for a VA home loan, the foreclosure waiting period can be two years if you re-establish credit.

The VA has no official minimum credit score to get a mortgage, but many lenders set their minimums at 620. The FHA allows a 90% mortgage to people with a credit score as low as 500 and 96.5% loans to those with FICO scores of 580 or better. However, most people who get approved at that level have some compensating factors like a larger down payment, extensive reserves (savings), or a low debt-to-income ratio.

Recovering From Bankruptcy or Foreclosure: What’s Easier?

As explained above, your recovery from bankruptcy or foreclosure depends a lot on what happens before the derogatory event. It’s easier to prove to future creditors that the event was an isolated instance and that it won’t happen again if your credit history before and after is good.

If you filed bankruptcy and reaffirmed (kept) some debts, continue paying them and do it on time every month. And if your filing was a Chapter 13, make your plan payments in a timely manner and continue to pay your secured debts on time. If you lost your home to foreclosure, pay every open account on time to re-establish a good payment history.

What if you discharged your debts in bankruptcy or your creditors closed your accounts?

In that case, apply for second-chance credit cards or a small personal loan. Be aware of the fees involved and avoid “fee harvesters” with very high annual fees and monthly maintenance charges. Make sure any card you choose reports your payment history to all major credit bureaus — Experian, Equifax, and TransUnion.

If you don’t qualify for a normal credit card, look at secured credit cards. Those cards require you to deposit an amount with them equal to your credit limit. Over time, they may increase your credit line and refund that deposit if you pay on time. However, these cards also tend to be expensive — look out for excessive fees and avoid carrying a balance.

Ask an Expert

If you can prove in writing that the bankruptcy or foreclosure was caused by events over which you had no control, like your employer going out of business, your waiting periods can be shorter. A good loan officer can help you write a letter of explanation and make your case.

If you have further questions about getting a mortgage after bankruptcy or foreclosure, contact us at Gustan Cho Associates at 800-900-8569. You can text us for a faster response or email us at gcho@gustancho.com.

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