There are times when foreclosure is inevitable. If you are falling behind on mortgage payments, there are a few things you can do to prevent a loan default and avoid foreclosure on your home. The first and most crucial step to prevent foreclosure is to take action. You need to do two things right away to avoid losing your home in foreclosure.
- First, you need to contact your mortgage servicer about new financial developments.
- Second, contact a HUD-approved housing counseling agency in your area. These two parties will work with you every step of the way and help you resolve the matter before things get out of hand.
When you default on your mortgage, the lender takes possession of the property and tries to sell it at auction to recover the remaining balance. If it is not auctioned, the lender keeps the property as real estate owned(REO).
A foreclosure will drop your credit score by as many as 100 points and damage your credit. Typically, a foreclosure stays on your credit reports for 7 years, impacting your ability to qualify for loans and credit cards.
In this article, I will walk you through clever tips to avoid foreclosure when facing financial setbacks.
What is a foreclosure?
A foreclosure is when the lender legally seizes your property, such as a home, when you can no longer repay your loan. After taking possession of the property, the lender will attempt to sell it in an auction to recover the remaining balance.
Your mortgage usually defaults after missing a few payments, but you might receive a notice of default(NOD) after 90 days without making payments. The default can also be triggered when you violate the terms of your loan. Foreclosures are costly to both the buyer and the lender. That is why most lenders will try to work with you and modify the loan terms to avoid foreclosure.
How to avoid foreclosure when falling behind on your payments?
Communication is usually the most critical step in avoiding foreclosure. Even if you don’t have enough money to afford your monthly payments, reaching out to your lender is an important step. Here are a few things to do when falling behind on your mortgage payments.
Work with a mortgage counselor.
An approved mortgage counselor can help you secure funding for your mortgage, negotiate a new deal with your mortgage lender, or help you move in the right direction. Again, you must reach out as soon as you learn about changes in your financial situation before it is too late.
Get a loan modification.
Facing foreclosure affects both the lender and the borrower, which is why most lenders consider alternatives to foreclosure. Your lender might agree to change the terms of the loan. For example, if you signed up for a 15-year fixed-rate mortgage and can no longer afford higher monthly payments due to a financial setback, your lender could change your loan into a 30-year fixed-rate mortgage.
This strategy will extend the loan term and lower your monthly payments. Another good example is when you have an adjustable-rate mortgage(ARM), and interest rates continue to rise. To prevent your mortgage rate from spiking further, you can request the lender change your mortgage into a fixed-rate mortgage(FRM). This will prevent your mortgage rate from going any higher and make it easy to afford your payments.
Request a different payment plan.
Sometimes, you might need to request a different repayment plan to prevent foreclosure. For example, after losing a job, your lender might allow you to pay the interest rate while looking for another job temporarily. So, as long as you are transparent and willing to work with your bank, paying interest only for a given number of months could be a viable option. Your mortgage servicer and its owner might also let you pay the outstanding balances in many smaller payments every month as opposed to a single payment.
Refinance your mortgage to a new one.
Mortgage refinance is an excellent strategy to avoid foreclosure when you fall behind on your payments. By refinancing your mortgage, you replace your existing mortgage with a new one with favorable terms and usually a lower interest rate. For example, if you bought a house when the interest rates were higher and have gone much lower ever since, you can refinance your home to get lower rates. Lower rates translate to lower interest charges and affordable monthly payments.
Mortgage reinstatement might be a good option.
The reinstatement allows you to pay all past-due amounts and accrued interest to keep your mortgage current. If you have fallen behind on your mortgage payments due to a short-term financial setback, such as a job loss, you can use the reinstatement options to avoid foreclosure. For example, if you recently got laid off but found a job in a few months, you can easily use this strategy to repair the damage after getting a job.
Request a waiver of penalties and fees.
Every credit account comes with late fees and penalties. If these fees make it harder for you to make your past-due balances, you can kindly ask your mortgage provider to waive these fees and penalties to avoid foreclosure. Waiving these fees will allow you to aggressively take control of your mortgage payments due to affordable monthly payments.
How can you avoid foreclosure when you cannot afford your monthly payments?
The last few tips to avoid foreclosure are effective when falling behind on your monthly payments. What if you cannot afford your monthly payments? How can you avoid foreclosure on a home in this case?
The property must be sold if you can no longer afford your monthly payments and want to leave the house. At this point, you must choose among the following three options to avoid foreclosure.
Traditional sales
When your home is worth more than you owe your mortgage provider, you might consider selling it in a regular sale. For example, if you owe the bank $100,000 and your home is worth $350,000, selling it and giving it its share of your proceeds would make sense. You don’t need to get approval from the bank to sell the house. However, you might need to check with an approved housing counselor to see if this is a good option.
Short sale
This is when you sell your home for less than it is worth. However, before you initiate a short sale, you will need your mortgage servicer’s and its owner’s permission to submit a loss mitigation application. If you sell the house for less than you owe the lender, you will be responsible for the remaining balance. For example, if you owe the lender $250,000 and the short sale generated $230,000, you will be responsible for the remaining $20,000. Some lenders usually forgive the remaining balance when it is small. Others, however, will require that you pay it off.
Try a deed-in-lieu of foreclosure.
Sometimes, avoiding foreclosure on a home requires surrendering your home and its title to the lender through a process known as a deed-in-lieu of foreclosure.
A deed-in-lieu of foreclosure allows you to move out of your home and turn over property ownership to your mortgage provider. Unlike in a short sale, where you are responsible for selling the property and paying the difference, a deed-in-lieu works differently. You will not be responsible for selling the property and might not be required to pay the difference if the house is sold for less than you owe.
You must submit the loss mitigation application and supporting documents to qualify for the deed-in-lieu option. If there are no other liens on the house, the mortgage servicer and the owner might approve your application.
Why do people get into foreclosure?
Many homeowners buy houses and later default on their loans. Even if the interest rates and monthly payments stay the same, a life event can easily cause you to default on your mortgage. Many people get into foreclosure due to the loss of their jobs. If you are laid off and cannot easily land another job quickly, it is almost certain that you will default on your loan. Other events that cause people to get into foreclosure are a reduction in income, too many medical bills, and accumulation of consumer debts such as credit card debts and personal loans. Other life events, such as the death of a partner or a divorce, can also contribute to a mortgage foreclosure.
How do you minimize the risk of foreclosure when buying a home?
Buying a home that reflects your current and future financial standing is the best way to avoid foreclosure. In other words, you need to buy a house you can afford. When it comes to affordability, however, many people make wrong choices. Just because a bank pre-approved you for $600,000 does not mean you need to spend the full amount when buying a house. You must buy a house that reflects your budget to avoid foreclosure shortly after closing.
You need a sizable down payment and enough income to make monthly payments.
Tips to minimize the risks of foreclosure when buying a house.
- Have a large downpayment. A sizeable downpayment lowers the amount you borrow, reducing interest charges. This, in turn, lowers your monthly payments and makes it easy to pay off your home.
- Have a good credit score. A good credit score makes you a prime borrower. Being a prime borrower means you carry less risks to lenders. For this reason, you will qualify for a lower interest rate on your mortgage. A lower interest rate will result in lower interest charges and affordable monthly payments.
- Buy a house you can afford regardless of what the bank approved you for. A common mistake many homeowners make is buying houses equal to or higher than the banks approved them for. Buying too much of a home means you will also be spending more money on maintenance, homeowners insurance, property tax, higher mortgage payments, etc. With this setup, a single financial setback can knock your finances off balance and land you in foreclosure. What you can do to minimize these risks is to buy a house that is within your budget.
- Buy a house that one spouse’s income can cover. If you are married, you might need to buy a home where all payments and extra expenses can be covered by one spouse’s income in your household. This strategy is so effective that even after a divorce, the death of a partner, expensive medical bills, and a loss of income, you will still be able to afford your monthly payments. The second income can be used to build your retirement savings account, emergency account, and investment portfolio. You can also pay extra if your lender has no pre-payment penalty.
Does a foreclosure hurt your credit?
Yes, a foreclosure hurts your credit. Not only will your credit score drop more than 100 points from a foreclosure, but this negative item will stay on your credit reports for seven years. Additionally, having foreclosures on your credit reports will impact your ability to qualify for loans and credit cards.
How do lenders treat a foreclosure?
The lending industry is solely based on risk assessment. Before anyone can be approved for a loan, lenders evaluate their creditworthiness. In other words, the lender needs to know how risky it is to lend you money. The riskier it is to lend you money, the higher the chance you will be denied credit. People with bad credit usually get denied credit, and if they get approved, their terms are stricter and costlier.
A foreclosure is one of the worst derogatory marks anyone can have on credit reports. Besides bankruptcy, which takes on the first spot, a foreclosure comes in the second spot. Lenders like borrowers who pay their bills on time. A foreclosure on your credit report shows that you have failed to make your payments, so you carry a higher risk of default. Since you failed to pay off your mortgage/loan in the past, you will more likely default on your loans in the future. Some lenders do not even consider applicants with foreclosure on their credit reports.
