If you're behind in your mortgage payments and facing a foreclosure, you might be thinking about different options, like giving up your home with a deed in lieu of foreclosure or filing for bankruptcy. With either one of these options, your credit scores will drop.
But is there a difference between filing for bankruptcy and completing a deed in lieu of foreclosure when it comes to how much your credit scores will fall? Will one impact your scores more than the other? Ultimately, foreclosures, short sales, and deeds in lieu of foreclosure are all similarly bad for your credit. Bankruptcy is worse.
A deed in lieu of foreclosure, commonly called a "deed in lieu," is a transaction in which the bank agrees to accept a deed to the property instead of foreclosing.
The impact that a deed in lieu has on your scores depends primarily on your credit history. If you had high credit scores to begin with, a deed in lieu will cause a bigger fall in your scores than if you started out with low scores. So, if you're one of the few borrowers who hasn't missed many payments—or any payments—before doing a deed in lieu, you'll likely see your scores drop 100 points or more. On the other hand, if you've missed a bunch of payments before completing a deed in lieu and had correspondingly low credit scores, your scores won't fall as much. According to FICO, if you start with a score of around 780, a deed in lieu (without a deficiency balance) shaves 105 to 125 points off your score; but if you start with a score of 680, you'll lose 50 to 70 points.
After a deed in lieu, it will likely take several years for your scores to recover—longer if your scores started out high. Though, the time it takes to rebuild credit is largely affected by your payment history and outstanding debt going forward. So, if you stay current on your bills and your available credit increases, your scores will likely rebound more quickly than if you continue to make late payments and stay overextended.
A bankruptcy is worse for your credit than a deed in lieu and other loss mitigation options. Again, if you had high credit scores to begin with, your scores will plunge more than if you started out with low scores. According to FICO, if you start out with a credit score of 780 and file for bankruptcy, you'll lose 220 to 240 points. If you have a score of 680, you'll lose 130 to 150 points.
Even though a bankruptcy will hurt your credit scores more than a deed in lieu, filing for bankruptcy might still be a good option, particularly if you have a lot of debts you can reduce or eliminate through the process. If you're eligible, you can discharge certain debts with a Chapter 7 bankruptcy, as well as delay a foreclosure, maybe by a few months, giving you some extra time to live in the home. (With a deed in lieu of foreclosure, you might have to move out sooner than you would after filing for bankruptcy.)
Bankruptcy can also be a good option if you want to catch up on your missed mortgage payments and keep your home. If this sounds appealing, you might consider filing a Chapter 13 bankruptcy.
It's virtually impossible to predict how much damage a bankruptcy or deed in lieu will do to your credit. For one thing, credit scoring systems change over time. For another, credit scoring agencies don't make their formulas public, and your scores will vary based on your prior and future credit practices and those of others with whom you're compared.
Credit scores are only one factor to consider if you're thinking about filing for bankruptcy or completing a deed in lieu. If you need help balancing the pros and cons of filing bankruptcy versus completing a deed in lieu of foreclosure or another loss mitigation option (or letting a foreclosure happen), consider talking to a bankruptcy attorney or a foreclosure attorney. If you need general information about how a deed in lieu of foreclosure works, or about other alternatives to foreclosure, like a loan modification or short sale, consider talking to a HUD-approved housing counselor.