Difference Between Bankruptcy and Foreclosure

Bankruptcy vs Foreclosure
 

An individual burdened with higher debt levels and a shortage of funds to repay debts maybe faced with bankruptcy or foreclosure. They are different from each other, because the implications to the defaulting party of either are very different. However, many people get easily confused with the two terms and mistakenly understand them to refer to the same thing. Nevertheless, it must be noted that bankruptcy or foreclosure can have negative effects on the borrower’s reliability, and may make it more difficult to borrow funds from financial institutions in the future. The following article clearly points out the differences between bankruptcy and foreclosure, how they are related to each other and what implications they may have on a borrower’s credit standing.

What is Bankruptcy?

A person has the option of filling bankruptcy when they feel they are at the risk of losing their assets (assets are usually homes bought through mortgage loans from banks). An individual has the option of filling for a chapter 7 or a chapter 13 bankruptcy. The filing of a chapter 13 bankruptcy will provide the individual around 3 to 5 years to pay their debt, and offer a repayment plan so that the individual may prevent the foreclosure of their home. This option will allow the individual to repay his debts according to the plan agreed at court so that he may keep his home, while repaying his debts at a slower pace. A chapter 7 bankruptcy filing acts as a statement of inability, to pay unsecured debts by the debtor. An unsecured debt is any debt that has been obtained without any collateral in place to be used in case the debtor defaults. Such debts include credit card debt, medical bills, etc. However, since a mortgage loan is not unsecured (the house bought must be kept as collateral, for the bank to sell and recover its debt in case the borrower defaults) chapter 7 bankruptcy filing does not cover loans made on mortgages.

What is Foreclosure?

Foreclosure is the process in which the mortgage loan borrower is evicted from his home on the grounds that he is unable to repay his debt. The reason for foreclosure to occur is that the borrower is unable to repay his loans, and so the collateral (the house on which the mortgage was taken) must be seized by the bank and sold off to recover the losses made. This was a common scenario during the financial crisis when the mortgage lending bubble blast. Many who face foreclosure have a number of options to protect themselves, out of which, one is filling for bankruptcy. A bankruptcy filing does not mean that the borrower will not have to pay all his debt, even though it may act as a temporary protection against losing all assets.

Bankruptcy vs Foreclosure

Bankruptcy and foreclosure go hand in hand even though their effects and legal proceedings are quite different to each other. Bankruptcy and foreclosure are both terms that are related to individuals or businesses facing liquidity issues in not being able to repay their debt. Foreclosure is when the borrower needs to surrender the asset bought through the bank in cases when he is unable to repay the debt he obtained to buy that particular asset (e.g.:- house). A bankruptcy, on the other hand, is used to stop foreclosure, as a bankruptcy filing will either eliminate the unsecured debt (chapter 7) or to consolidate and adjust a debt repayment plan (chapter 13). However, it must be kept in mind that both bankruptcy and foreclosure will remain in the borrower’s credit report and affect their creditworthiness.