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 important step to prevent foreclosure is to take action.
- First, you need to contact your mortgage servicer about new development in your finances.
- Second, you need to contact a HUD-approved housing counseling agency. 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 mortgage owner takes possession of the property and tries to sell it to recover the money you owe on your mortgage. By taking the property, the lender might not be able to sell it through an auction. As a result, the lender could keep the property as real estate owned(REO) which will cost them more money in insurance, taxes, etc.
It is a financially sound decision to do whatever you can to avoid foreclosure as a borrower. A foreclosure will lower your credit score by as many as 100 points and the health of your credit will be in jeopardy. A foreclosure on your credit reports will make you a risky borrower. As a result, many lenders will deny you credit or charge you a higher interest rate with stricter terms.
This article will walk you through possible ways to avoid foreclosure and how to minimize the risks of defaulting on your loans when buying a house.
What is a foreclosure?
A foreclosure is a process in which the lender legally seizes your property such as a home, car, and other assets when you can no longer afford to make your loan payments. After taking possession of the property, most lenders sell them during auctions in an attempt to recover the remaining balance. The lender usually considers the loan to be in default after you have missed a given number of 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 even modify the terms of the loan to avoid foreclosure.
What should you do when you are 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.
- Get a loan modification. Facing a foreclosure affects both the lender and the borrower. That is why most lenders consider alternatives. 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 you 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 length of 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 any further, you can request the lender to 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.
- Have a different payment plan. There are times when you might need to come up with a different repayment plan to prevent foreclosure. For example, if you just lost a job, your lender might allow you to temporarily cover the interest rate while you are looking for another job. So, as long as you are being transparent and willing to work with your bank, paying interest only for a given period of time 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 a great strategy for people who want to avoid foreclosure. By refinancing your mortgage, you replace your existing mortgage with a new one that has favorable terms. For example, if you bought a house when the interest rates were higher and rates have gone much lower ever since, you can refinance your home to get lower rates. Lower rates translate to lower interest charges and favorable monthly payments.
- Mortgage reinstatement might be a good option. The reinstatement allows you to pay all past-due amounts and accrued interest to bring your mortgage to its current status. If you have fallen behind on your mortgage payments due to a short-term financial setback such as a loss of a job, you can use the reinstatement options to avoid foreclosure. For example, if you recently got laid off but find 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. In case these fees are making it harder for you to make your past-due balances, you can kindly ask your mortgage provider to waive these fees and penalties. Waiving these fees will allow you to aggressively take control of your mortgage payments due to affordable monthly payments.
How to avoid foreclosure when you cannot afford your monthly payment?
In case you can no longer afford your monthly payments and want to get out of the house, the property must be sold. At this point, you must choose among the following three options to prevent foreclosure.
- Traditional sales. When your home is worth more than you owe your mortgage provider, you might consider selling your home and giving the bank the difference. For example, if you owe the bank $100,000 and your home is worth $350,000, it would make sense to sell it and give the bank its share of your proceeds. You don’t need to get approval from the bank to sell the house. But you might need to check with an approved housing counselor to see if this is a good option for you.
- Short sale. This is when you sell your home for less than what it is worth. Before you initiate a short sale, however, you will need permission from your mortgage servicer and its owner by submitting a loss mitigation application. If you end up selling 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 might forgive the remaining balance usually when it is a small amount. Others, however, will require that you pay it off.
- Deed-in-lieu of foreclosure. This strategy allows you to move out of your home and turn over ownership of the property to your mortgage provider. This strategy helps homeowners to avoid foreclosure. Unlike in a short sale where you are responsible for the sale of the property and paying the difference, a deed-in-lieu operates a little differently. You will not be responsible for selling the property and you might not be required to pay the deficiency if the house is sold for less than you owed. You must submit the loss mitigation application, and supporting documents to qualify for the deed-in-lieu option. The mortgage servicer and owner of the mortgage will approve your application if there are no other liens on the house.
Why do people get into foreclosure?
A lot of homeowners buy houses and later fail to pay their mortgage monthly payments. 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 you cannot easily land another job, 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 a death of a partner or a divorce can also contribute to a mortgage foreclosure.
How to minimize the risk of foreclosure when buying a home?
The best way to avoid foreclosure is to buy a home that reflects your current and future financial standing. In order words, you need to buy a home you can afford. When it comes to affordability, however, many people make wrong choices. Just because a bank pre-approved you for $600,000, it does not mean you must spend that amount on the house. You need to make smart choices when buying a house to avoid foreclosure in the near future.
The following are tips to help you minimize the risks of foreclosure when buying a house.
- Have a large downpayment. A large down payment lowers the amount you are borrowing. By borrowing less money from the bank, your interest charges also go lower. This in turn lowers your monthly payments and makes it easy to pay off your home.
- Have a very good credit score. A good credit score makes you a prime borrower. Being a prime borrower means you are a less risky borrower. 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 to buy houses equal to or higher than what the bank approves them for. Buying too much of a house means you will also be spending more money on maintenance, homeowners insurance, property tax, higher mortgage payments, etc. With this kind of 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 can be covered by one spouse’s income. In case you are married, you might need to buy a house 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, and expensive medical bills, you will still 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 in case your lender does not have a pre-payment penalty.
Does a foreclosure hurt your credit?
Foreclosure negatively affects your credit. Not only that your credit score will tank from a foreclosure, but also this derogatory mark will stay on your credit reports for 7 years. Your credit score can easily slide as many as 100 points from a foreclosure.
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 his/her creditworthiness. In other words, the lender needs to know how risky it is to lend you money. The riskier you are, 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 pretty much takes on the first spot, a foreclosure comes in the second spot. Lenders like borrowers who pay their bills on time. Having a foreclosure on your credit report shows that you have failed to make your payments, and therefore, you are a risky borrower. 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.
