Your mortgage–filing bankruptcy and your credit score

Your mortgage–filing bankruptcy and your credit score

Clients sometimes ask how filing bankruptcy will impact their credit scores. I’ve found that this question most likely comes when a client is deciding whether to file bankruptcy and surrender their house, do a short-sale on their property, or try to stick it out long enough for their pending loan modification to be finalized.

Well someone has been crunching numbers, and has given us some sort of answer. Kenneth R. Harney a Washington Post columnist wrote a piece on September 12, 2009 published here.

I’ll give you the summary, but I want you to read this entire blog post because I’ll respond to what I think you’ll be thinking when you read the summary. I don’t question the validity of the Harney report. I do want you to be an informed consumer, and I think you need to talk to an attorney who will go over the entire picture of your debt and advise you.

Here’s the skinny on the Harney piece:

Mr. Harney looked at a report published by VantageScore Solutions which is an entity created by the three bureaus. VantageScore Solutions is apparently used by many mortgage companies and banks to determine whether a consumer is ‘mortgage-worthy.’ (This it is NOT your FICO score.)

The report says that a load modification directly with your lender where you agree to include your arrearages and penalties in the principal, and then pay them back over time may help your score.

Loan modifications involving property that is underwater or negative equity appear to be score-neutral. (These are the Obama modifications.)

Both of these findings are good news for folks who can afford to keep their property, and do not need to consider selling or surrendering! And these numbers are not really a surprise.

The report also says that filing bankruptcy will send your credit score down an average of 350 points. Yikes. This finding may terrify you, but it doesn’t surprise me at all. Bankruptcy still may be a better option for you–please keep reading and I’ll explain.

The surprise is that a short-sale and a foreclosure have about the same impact on consumers’ scores. Both will send your credit score down by 125-145 points. This finding is critically important for the folks who can’t afford their property and who are looking down the barrel of an extremely tough decision.

This means regardless of whether you go through the gray-hair-and-wrinkle-inducing short sale, or if your property is foreclosed, your credit score is going down. I sometimes meet clients who say that their real estate agent suggested that they’d be better off if they agreed to short-sell the property rather than allowing the property to foreclose. Guess who still gets a sales commission on the short-sale?

I have always questioned that wisdom because of the nature of the short sale–it’s never a sure thing. Sometimes the bank will forgive the deficiency involved in a short sale, and sometimes it won’t And in Georgia, guess who may liable for the deficiency between the amount of the short-sale and the balance on the mortgage unless it’s forgiven?

If there is no real difference in impact on your credit score between short-selling and foreclosing–why go through the pain? One may as well wait it out until foreclosure day. (NOTE–Please don’t call me next month and say that I told you on my blog to wait until foreclosure–I’m telling you to talk to an attorney.)

And this is why I wanted you to keep reading (thank you).

Bankruptcy is a holistic approach to problem solving. We don’t just solve one problem with one creditor. If the only problem a client has is mortgage payments, and if there are no unhappy creditors, and no unpaid debts, I suppose it is possible that loan modification is a better alternative than considering filing bankruptcy.

What I see most often is that credit scores–FICO credit scores–are annihilated because there are many creditors and many debts. Dings will impact your credit reports and FICO score for 7 years. The statute of limitation for the collection of unpaid credit card debt in Georgia is six years from default. Yes, that means that you will be harassed and sued, and garnished for a long, long time.

Filing bankruptcy will appear on your credit report for as long as 10 years. But once discharged you cannot be sued, and you are not obligated to pay back the debt. This means that you can file bankruptcy and spend the next several years after discharge rebuilding your credit score.

Pick the number of years and gray-hairs with which you are comfortable, and then call me.