People who suffer financial reverses may find themselves in a situation where they know they can't continue making their mortgage payments. If this happens, you should develop a game plan before you become delinquent. Here are the major components of such a plan.
Document your loss of income. This will position you to demonstrate to the lender that your inability to pay is involuntary, should this be necessary later on.
Estimate your equity in the house. Your equity is what you could sell it for net of sales commissions, less the balance of your mortgage. This will help you develop a strategy for dealing with the lender.
Determine realistically whether your financial reversal is temporary or permanent. A temporary reversal is one where, if you are provided payment relief for up to 6 months, you will be able to resume regular payments at the end of the period, and repay all the payments you missed within the following 12 months. Set down the case for the reversal being temporary in writing.
If you can't meet these conditions, your financial reversal is considered permanent by the lender. If the change in your status is permanent, it means that you can resume regular payments only if the payment is permanently reduced. This requires modifying the loan contract: reducing the interest rate, extending the term or both.
You need to understand the position of the lender. While some actions you can take on your own, such as selling your house, other actions have to be negotiated with the lender. You do better in any negotiation if you know where the other party is coming from.
The lender's objective is to minimize loss. The action that minimizes loss to the lender depends on the equity in your house, on whether your financial reversal is temporary or permanent, and on whether or not you are dealing in good faith.
Substantial Equity. If you have substantial equity in your house, the least-costly action to the lender may be foreclosure. While foreclosure is costly, the lender is entitled to be reimbursed from the sales proceeds for all foreclosure costs plus all unpaid interest and principal.
While foreclosure makes the lender whole, it is a disaster for you. Your equity is depleted, you incur the costs of moving, and your credit is ruined. Hence, you must avoid foreclosure, if necessary by selling your house.
If your financial reversal is temporary, and you can persuade the lender of this, the lender may be willing to provide payment relief. The lender will probably prefer to keep your loan, rather than to foreclose on it, but only if it is a good loan. The burden of proof is on you in this situation to demonstrate that the relief will really work. It also helps if your state has an assistance program for borrowers experiencing mortgage hardship, which assumes some or all of the risk of providing payment relief.
If your financial reversal is permanent, sell the house before you begin accumulating delinquencies. In a high-equity situation, there is little hope that the lender will agree to modify the loan contract, so don't waste time trying. If you sell, at least you retain your equity and your credit rating.
Little or No Equity. If your financial reversal is temporary and you have little or no equity in your property, it will be easier to persuade the lender to offer payment relief. With no equity, the foreclosure alternative is more costly to the lender.
If your financial reversal is permanent, the lender probably will be willing to accept either a "short sale"
or a "deed in lieu of foreclosure." In the first, you sell the house and pay the lender the sales proceeds while in the second the lender takes title to the house. In both cases your debt obligation usually is fully discharged. (They do appear on your credit report, but are not as bad a mark as a foreclosure.) The lender who can get all or most of his money back in these ways probably will not be willing to modify the loan contract.
The lender will turn a wary eye on borrowers who have the means to continue making payments but would like to rid themselves of their negative equity through short sale or deed-in-lieu. While these options are less costly to the lender than foreclosure, lenders view borrowers as responsible for their debt, regardless of the depletion of their equity. How they respond depends on how convinced they are that the borrower's problems are truly involuntary, and on the likelihood of success in collecting more if they elect to go after the borrower for the deficiency.
If your equity in the house is negative but you want to remain there, the lender may be favorably disposed to payment relief, or to contract modification if necessary to make the payment manageable. With negative equity, these may be the least-costly options for the lender.
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