What to Do When You Can’t Pay the Mortgage

If you’re having trouble making your house payments, the first thing to know is that you are not alone. Home mortgage defaults are at an all-time high across America. This is good news for you, because it means that mortgage lenders are familiar with people in default on their home loans and often have established programs and policies to deal with such situations.

Let’s begin with a definition

“Foreclosure” is the right of a mortgage lender to sell your house at a public auction and keep the proceeds if you fall behind on your mortgage and don’t take steps to get back on track or work out another solution. There are two different kinds of foreclosure. One is called a “judicial foreclosure” because the lender must file papers in court and obtain the court’s approval before foreclosing. This kind of foreclosure can take as long as 18 to 36 months before you would ever lose your house. Most states have judicial foreclosures. If you signed only a traditional mortgage note when you purchased or refinanced your property, your lender probably must use a judicial foreclosure to sell your house.

The other kind of foreclosure is called a “nonjudicial foreclosure” because the lender does not have to go to court in order to foreclose. Instead, a third-party trustee sells your property after sending you a series of notices. The trustee is the person or business named in a deed of trust which you signed instead of, or in addition to, a traditional mortgage when you purchased or refinanced your property. Non-judicial foreclosures can happen quickly, sometimes in as few as four months.

It’s very important that you know if you signed only a traditional mortgage or a deed of trust. Your options for dealing with your house may depend on how much time you have.

You also need to determine your ultimate goal. Is it to save your house at all costs? Let it go for the minimum possible damage to your credit? The options you want to pursue will depend on your desired outcome.

So what are those options?

Find Money to Get or Stay Current

As odd as it sounds, some people never consider borrowing money from friends or relatives to get current on their home loan.

This is probably not an option for someone substantially behind on payments, someone unemployed or otherwise unable to catch up or someone who wants to unload the property. But if you need help for a month or two, consider asking those who love you most and would want to help you out.

In addition, if someone co-signed your loan for you when you bought or refinanced, go to that person at once. First, you have an ethical duty to let the person know you are at risk of defaulting or that you already have. Secondly, your co-signer will want to avoid damaging his or her credit file and may lend you the money to get and stay current, share in the monthly payments or take over payments until you work out another solution.

Contact Your Lender

Maybe this is obvious. But if you want to keep your house and you are having trouble paying your mortgage, even if your lender has started the foreclosure process, contact the lender and try to work out a deal.

Before taking back your house, your lender would probably rather rewrite your loan, suspend principal payments for a while (have you pay interest only), reduce your payments, let you miss a few payments and spread them out over time or give you an interest-free loan to get current. Why would a lender do any of these things? Mortgage lenders are in the business of making money. They don’t make money by trying to resell distressed real estate. (“Distressed” is a term used to describe a piece of property that’s been foreclosed.) They do make money when you make payments, particularly interest payments, on an outstanding loan.

If your loan is held by the federal government, Fannie Mae or Freddie Mac, you may have some extra good news. In 1997, both programs made radical changes to their home loan default programs, emphasizing foreclosure prevention whenever possible. Both Fannie Mae and Freddie Mac offer rate reductions, term extensions and other loan modifications for people experiencing involuntary money problems. One option would allow you to make reduced payments for up to 18 months. If you can’t get help from your loan servicer, you can call either loan holder directly at 202-752-7000 (Fannie Mae) or 800-373-3343 (Freddie Mac).

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Keep in mind one thing: if you truly can’t afford to keep your house, negotiating for a new loan or temporary suspension of payments may not help you in the long run. You may be wasting your time and money if you try desperately to hold on to a house you honestly can’t afford.

Find a Good Mortgage Broker

Again, this is an option to consider if you want to hold on to your house. If you have tried negotiating with the lender and can’t come up with a deal that you can afford, don’t give up. A licensed mortgage broker might know of more options. Good mortgage brokers have access to information about hundreds of loans offered by banks, savings and loans, finance companies and other mortgage lenders. You may find yourself able to refinance and bring your payments down dramatically, at least temporarily.

Consider the case of Tony, who several years ago had a fixed rate mortgage at 11 percent. After he lost his job, he struggled for months to make his house payments. Then he met with a mortgage broker who knew about an adjustable rate mortgage that started at three percent, rising one percent every six months. Tony jumped at the loan, brought his payments down significantly and was able to keep his house while he spent another full year looking for a new job. After the interest rate climbed back well-above the going rate for mortgages, Tony refinanced again and currently has a loan at 7.5 percent.

Contact Your Private Mortgage Insurer

If you made a down payment on your house of less than 20 percent of the purchase price, your lender probably required you to take out something called private mortgage insurance, or PMI. You were required to buy PMI because by borrowing more than 80 percent of the purchase price you are in greater risk of default than someone who borrows 80 percent or less. When you took out the loan, you probably cursed the extra amount you were required to pay each month for PMI. But if you’re having trouble paying your loan, PMI could actually help you. The insurance company may loan you money to meet any shortage to prevent foreclosure.

Sell the Property

You are certainly better off selling the house than having it go to foreclosure. If you can find a buyer who will offer to pay at least what you owe your lender, take the offer. Ideally, you will find a buyer who is willing to pay the amount you owe your lender and any other lienholders, such as a second mortgage lender or the IRS if the taxing agency has recorded a lien against you for unpaid taxes. There are investors who specialize in buying real estate heading for foreclosure. You won’t get top dollar and you may lose any equity you have in the property, but it’s still better than having the lender foreclose.

When listing your house with a real estate agent make sure that you are being realistic about the sales price. Often real estate agents will tell you they can get a high price for your home because that is what you want to hear. However, if what you really need is a quick sale you might want to think of listing your home for a bit less than the going rate. What you need is for the home to sell for an amount more than the mortgage balance, before the auction date. Sellers in foreclosure often get greedy and try to get the highest price possible only to watch their house sit on the market without any takers.

Be careful of people who advertise as pre-foreclosure investors, however. Some of them are sharks. For example, don’t agree to deed your house to someone who promises to sell it for you. The person will more likely collect rent from you, not make any mortgage payments, not try to sell the property and just let the lender foreclose. Although the deed isn’t in your name, the mortgage still is and you are still liable on it. The foreclosure will go on your credit record and you may owe any shortfall between the auction price and your total balance due.

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In addition, be sure to get all understandings in writing. If you have any doubts about the person with whom you are dealing, ask for the names and phone numbers of references, and call them. Then call your state Department of Real Estate to ask about the investor. If anything sounds fishy, don’t pursue the deal.

You may be anxious to walk away from your house because it has depreciated in value and you owe your lender more than the house is worth.

Up until a few years ago, you would have had a hard time selling your house under such circumstances. That’s because your lender can block any sale if it won’t bring in at least the amount you owe the lender. But lenders began to realize that getting something is better than getting nothing.

Today, many lenders will agree to a “short sale.” This is a situation in which the sale of the house brings in less than you owe the lender, but the lender agrees to forgive a portion or all of the difference.

A lender will not typically agree to a short sale unless you provide documentation of financial or medical hardship you are experiencing, that is, unless you can justify to the lender why you are having trouble paying. Divorce, job layoff, unexpected living expenses, illness or death, those are usually acceptable reasons.

So is a lack of cash reserves because of extraordinary and unexpected expenses, such as a required move due to a job change resulting in your paying the mortgage on your old house and housing expenses for your new home.

As mentioned, documentation is key. Be prepared to provide your lender with recent tax returns (anywhere from one to three years) and one of the following types of information:

  • letters from doctors documenting health problems
  • efforts of your job search
  • divorce decree specifying who pays what and default notices if your spouse was ordered to pay bills but has not, or
  • efforts you’ve made to sell your home

Deed the Property Back to the Lender

If you get no offers for your house or the lender won’t approve a short sale, which especially may be the case if your loan is held by Fannie Mae or Freddie Mac or was issued by the Federal Housing Administration, consider walking away from your house. Call the lender and ask if it will accept your deed in lieu of foreclosing. Many will.

If the lender won’t, prepare what’s called a quitclaim deed, you “quit” your interest in the property and transfer ownership to your lender. You write DEED IN LIEU OF FORECLOSURE in block capital letters across the top of the deed, pay any transfer fee, record the quitclaim deed where you recorded your ownership deed and mail a copy of the recorded quitclaim deed to the lender. You no longer own the house. Your lender does.


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Damon Day - Pro Debt Coach

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Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.
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