Inability to discharge financial obligations results in bankruptcy. Defaulting on mortgage payments results in foreclosure. Both bankruptcy and foreclosure have a negative impact on the credit scores and they make it increasingly difficult for the debtor to obtain loans at some point of time in future. Both result in a person's credit score declining by as much as 300 points. People are forced to work towards building their credit score and establishing a good credit history. However, the similarities between the two legal proceedings end here. Examining the differences may help a person decide, which is better of the two. The Differences Causes: Foreclosure is the result of a home owner being unable to make regular mortgage payments. Defaulting on mortgage payments results in the home reverting to the lending institution, since the home is the collateral for the loan. Bankruptcy, on the other hand, is the result of a person being unable to discharge debts. The debts do not necessarily refer to mortgage payments. Borrowing money in order to pay off medical bills, or to salvage a failed business undertaking, may result in bankruptcy. Who Initiates Legal Proceedings?: In case of bankruptcy, legal proceedings are initiated by the debtor himself. The debtor can file bankruptcy under Chapter 7, or Chapter 13 of the US Bankruptcy Code. Creditors initiate foreclosures in order to recover mortgage dues. Cost: Foreclosure proceedings cost the lender a lot of money. Hence, in order to avoid a foreclosure, the lender may be willing to consider a short sale. Filing for bankruptcy, under Chapter 7, generally costs $300 while filing under Chapter 13 costs more. Hence, most debtors prefer filing under Chapter 7. However, this is possible only if the debtor meets the requirements laid down by the Bankruptcy Means Test. Liability: In case of a foreclosure, the extent of liability would depend on whether the mortgage is a recourse or a non-recourse loan. In order to settle non-recourse loans, the borrower is not liable to pay the dues using personal property other than the home which functions as the collateral for the loan. In case of filing bankruptcy under Chapter 7, a person's debt obligations are not eliminated. In fact, an individual's Investment Retirement Account can be used to settle dues. Chapter 13 is only meant for people with regular income. It aims at helping people discharge their debts under a different set of covenants. The dues have to be settled within a period of 5 years. Moreover, people may be able to retain possession of their homes. Waiting Time to Seek Home Loans: Freddie Mac and Fannie Mae have recently increased the waiting period for seeking conventional mortgage loans after foreclosure. Hence, in case of conforming loans, the borrower needs to wait for 5 years after completion of a foreclosure. For the purpose of availing FHA (Federal Housing Administration ) or VA (Veterans Affairs) insured loans, the borrower needs to wait for 3 years, after completion of a foreclosure sale. In case of bankruptcy, a person is eligible for FHA or VA guaranteed loans after 2 years from the date of filing. Of course, getting a mortgage is subject to a person having built a good credit score. Staying on Record: Filing bankruptcy under Chapter 7 stays on the credit record for 10 years from the date of filing. A foreclosure on the other hand stays on the credit report for seven years. Filing under Chapter 13 may not stay on record for more than 7 years. Which is Worse? People may be able to avoid foreclosures by filing for bankruptcy. For people who have a regular income, discharging debts under a different set of covenants is a distinct possibility. Filing under Chapter 13 helps people retain their home, while obligating them to repay the debts within 5 years. However, if people are unable to discharge their debts within 5 years, foreclosure becomes imminent. This is the worst possible situation, since in addition to bankruptcy, people would also have a foreclosure on their record. In this situation, opting for a foreclosure may have been a better option. Hence, instead of choosing bankruptcy to avoid a foreclosure, one should try and persuade the lender to allow short sales. The government is helping people to avoid a foreclosure by providing various incentives to the lender. The government is also helping people refinance their mortgage or reduce the mortgage principal that is due. These measures will help people avoid a foreclosure. Hopefully, one would not have to choose bankruptcy in order to avoid a foreclosure.