Hopefully, by clearing up a few common misconceptions, you'll be better equipped to choose the most effective course of action for your situation.
Misconception #1: A foreclosure is better for my credit than filing for bankruptcy. Sometimes this is true, and other times it's not. Typically, you'll get a different opinion depending on the source. Ultimately, it depends on how the action is reported to the credit agencies and how many other negative reports are made, including the number of late payments or non-payments related to your mortgage. A bankruptcy may even "hide" a foreclosure on your credit report if the property is included in the bankruptcy. There is no guarantee, however, so to be safe, always try to sell your property outright and use a short sale if necessary -- even if the property is included in the bankruptcy filing. If the short sale is reported, it will show up as a "settled debt" rather than a "foreclosure," which is basically a repossession of the property for non-payment without the debt being satisfied. The short sale will also lessen your liability in a potential "deficiency judgment" brought on by your lender at a later date. Misconception #2: If I file for bankruptcy, I get to keep my house. This is not necessarily accurate. And in most cases, it doesn't work out this way in the end. In a chapter 13 bankruptcy case, your attorney may be able to negotiate a reduced mortgage payment, and/or principal loan balance. However, if you're unable to make your new mortgage payments, and do so on time, you'll lose the protection of the bankruptcy, and the foreclosure proceedings will resume. In a chapter 7 filing, you have really no choice but to give up your house. Either you make up any back payments and keep paying, or the lender will initiate the foreclosure process. However, you can still mitigate some damage at this point and attempt a short sale in order to limit your liability to further credit damage and a larger deficiency judgment. Misconception #3: To avoid bankruptcy, I can use a debt management program to lower my payments and avoid filing for bankruptcy. If you do choose to go with a debt management service, be sure that you have the resources to make your modified payments, and you may very well be able to avoid a bankruptcy all together. Just be very careful which debt management program you choose. If they ask for any kind of money upfront, you're dealing with the wrong company. Only enlist the services of non-profit debt management organizations. They will charge a small monthly service fee along with your agreed-upon payoff amount.
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If your ultimate goal is to keep your house and you have a reliable income, your best option is to contact your lender first to see if they'll work out a repayment plan with you. If the bank does not work with you and you have other delinquent debt(s), especially credit card debt, you should consult a qualified attorney regarding your bankruptcy options. In some cases, the attorney can negotiate lower payments for you.
If you're just flat out of money, it may be prudent to consider giving up your house and focus on mitigating damage to your credit. To do this, don't let the bank foreclose on your property; instead, find someone you trust to handle selling your house using a short sale as quickly as possible. You may want to file for chapter 7 bankruptcy, depending on how much you owe and the amount of your assets.
If you can afford it, work with a not-for-profit debt management company to lower the payments on your unsecured credit cards debt and avoid filing for bankruptcy.
Disclaimer: I'm not a certified accountant or a licensed attorney.
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