A foreclosure affects only the home that secures the delinquent mortgage. However, a bankruptcy involves all of your property. You list real estate and personal property, as well as your debts in a bankruptcy. A trustee assumes control of these and can pay creditors up to the value of any collateral you may have for secured debts. If anything remains, it's applied to your unsecured debts, such as credit cards, medical bills and personal loans. Most of your debts are discharged, meaning you can't be sued for them.
Foreclosure and bankruptcy are two distinct legal processes with different purposes and outcomes. In the former, a lender sells your home because you fall behind on payments. A bankruptcy is usually your attempt to rid yourself of debt you can't repay and which often threatens your home. A home in foreclosure is likely evidence of a shrinking income, mounting debt and a need for bankruptcy.
What Property Is Involved?
Is Your Property Underwater?
If a foreclosure sale doesn't fetch enough to pay the mortgage debt in full, you have a deficiency. If your state allows it, the lender can sue you and get a deficiency judgment. Many states limit a bank's ability to recover more than the proceeds from a sale. In a bankruptcy, a mortgage with a balance that exceeds the property's value results in an unsecured claim for the shortfall. The deficiency and your other unsecured debt gets paid from the non-exempt property, if any, in the bankruptcy case.
If There's a Surplus
Should your property sell for more than the debt in a foreclosure, the surplus is applied to pay off other debts attached to your land, in order of their filing. These include judgment liens, contractor liens for work and materials furnished to the property, and junior mortgages. You get what remains after these debts are satisfied; unsecured creditors get nothing from your property if it is sold in foreclosure. In bankruptcy, after you pay all of your secured creditors, what is left goes to you, up to a certain amount. The bankruptcy trustee uses the rest to pay your unsecured debts.
The Tax Bill
If the foreclosure sale brings more than the debt, you must report a gain on your income taxes; if the sale proceeds are lower than the debt, you can claim a loss. Unless you took the loan in question to buy your home, you may also have to pay cancellation of debt income if the bank decides to forego recovering the deficiency from the foreclosure sale. Debts discharged in bankruptcy do not count as taxable income.
Keeping Your Home
Depending on your state, you can rescue, or redeem, your home even after a foreclosure sale by paying off the mortgage balance and the lender's foreclosure costs. If you want to keep your home and have regular income, but substantial unsecured debt, you can file a Chapter 13. Under a bankruptcy wage-earner plan, you pay a certain amount of your income toward your mortgage and at least part of your unsecured debts.
If you face foreclosure or file for bankruptcy, your credit has already been tarnished. Missed or late payments and delinquent accounts referred to collection can stay on your credit report up to seven years. Your credit report will show a foreclosure for seven years. Chapter 7 bankruptcies last 10 years on your report, though if you take the Chapter 13 route, a bankruptcy will be reported for seven years.
- U.S. Department of Housing and Urban Development: Avoiding Foreclosure -- Foreclosure Process
- United States Courts: Bankruptcy Basics
- Internal Revenue Service: Tax Topics -- Topic 431 -- Canceled Debt – Is It Taxable or Not?
- Internal Revenue Service: Publication 4681 -- Canceled Debts, Foreclosures, Repossessions, and Abandonments (For Individuals)
- MyFICO.com: Credit Report Questions and Answers: Chapter 7 & 13 -- How Long Will Negative Information Remain On My Credit Report?
- New Jersey Judiciary: Frequently Asked Questions -- Foreclosure
- American Bar Association: Strategic Default in Anti-Deficiency States; Mariana E. Gomez
- United States Bankruptcy Court: Western District of North Carolina: Proof of Claim Instructions
- U.S. Department of Housing and Urban Development: Redemption
- Photo Credit Andy Dean/Hemera/Getty Images
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