Is Bankruptcy or Charge-Off Better for Mortgages?
How Does a Charge-Off Work?
- When you allow the mortgage balance on your home to go partially or fully unpaid for a substantial period, the mortgage company can choose to write it off. A written off mortgage balance means you are no longer liable for the remaining debt. Not all lenders provide homeowners with this option. Some lenders pursue judgments in court for the remaining balance once the process is complete. However, this is more likely to occur with a foreclosure.
- By definition, a deed in lieu of foreclosure grants you automatic debt forgiveness in exchange for the deed to your home. A short sale occurs when the lender allows you to sell your home for less than the remaining balance on the loan. To qualify for cancelled mortgage debt with a short sale, you must negotiate this at the time you apply for a short sale. Homeowners experiencing foreclosure have few options to negotiate the outcome of their mortgage loan balance.
- One of the biggest disadvantage to debt cancellation, or a charge-off, is IRS penalties. With the Mortgage Debt Relief Act of 2007, homeowners with debt cancelled between 2007 and 2012 are protected from cancellation-of-debt taxation as long as the debt cancelled was from a primary residence and the amount of the cancelled debt is less than $2 million. If your cancelled debt does not meet these criteria, you may be subject to taxation on the forgiven debt.
What Is Bankruptcy?
- Bankruptcy is the process of legally eliminating some or all of your debts. When you file bankruptcy, creditors are unable to resume collection activities under most circumstances. This process is called a motion to stay. If your lender already has filed foreclosure, getting the bankruptcy court to file a motion to stay against your lender may be difficult. The lender can file a motion to lift the stay, which means foreclosure resumes. Chapter 13 bankruptcy is the bankruptcy of choice when it comes to saving a home from foreclosure, because Chapter 7 requires liquidating your nonexempt assets to repay creditors.
- With a mortgage charge-off or bankruptcy, your credit score suffers significantly. With a bankruptcy, however, your score drops more. According to CNN Money, your score drops as much as 240 points after you file bankruptcy. With a short sale, deed in lieu or foreclosure, your score drops as much as 160 points. Also, recovery from bankruptcy can take up to 10 years, because it remains on your credit report for up to a decade. Foreclosures, short sales and deed in lieu of foreclosures are erased in only seven years.