Homeowners in default on their mortgages often seek ways to solve their problems through a number of solutions generally termed as foreclosure loss mitigation. Depending on your situation and your lender, a wide number of foreclosure prevention options may be available to you. Some of these options would allow you to remain in your home; others would allow you to walk away from both your home and your mortgage with no further obligation to your lender.
If you’re in default but want to avoid foreclosure, the first thing you should do is talk to your lender. Both you and your lender stand to lose out if your home is sold at a foreclosure auction. For this reason, lenders will often initiate the foreclosure prevention process by contacting eligible homeowners and recommending one of the loss mitigation options described below.
Loss Mitigation Options if You Want to Keep Your Home
For some homeowners hoping to avoid foreclosure, their primary goal is to keep their home. If you feel this way, here are some options you should investigate:
- Forbearance—A forbearance agreement would allow you to become current on your mortgage payments over a short period of time (typically three to six months). During the forbearance period, you would make reduced payments or no payment at all. Any unpaid amounts are added back into the original loan amount or repaid according to the terms of the forbearance agreement. Forbearance is designed to help borrowers with temporary financial problems, so not all homeowners facing foreclosure will qualify for such an agreement.
- Loan modification—With a loan modification, your lender agrees to modify the terms of your mortgage loan to make the mortgage payments more manageable for you. Common modifications include reducing principal, lowering the interest rate, converting an adjustable-rate mortgage to a fixed-rate mortgage, forgiving past due payments, and lengthening the term of the loan.
- Loan refinancing—To refinance your mortgage, you need to get a new home loan from another lender or your current lender on terms that are better than the terms of your current mortgage (for example, lower interest rate or longer repayment period), making your monthly payment more affordable. You would then use the proceeds from your new loan to pay off your old loan. Refinancing will be near impossible if you, like many other homeowners, are upside-down on your mortgage (the value of your home is less than the balance of your mortgage).
Loss Mitigation Options if You Don’t Mind Losing Your Home
If you want to avoid foreclosure but don’t mind losing ownership of your home, you should consider the following loss mitigation options:
- Short sales—In a short sale, you sell your home at a price that is less than the amount owed on your mortgage. If you have enough cash to make up the difference (known as the “deficiency”), the sale would proceed like a regular home sale. If you don’t have the resources to pay off the deficiency, and you live in a state that allows lenders to sue borrowers for the deficiency, you would need your lender’s approval for the short sale to close. If there is a second mortgage or other liens on your home, you would also need the approval of these other debt holders.
Some lenders will agree to release you from repaying deficiency amounts. Make sure to get this release in writing so the bank can’t come after you once you get back on your feet financially. Be aware that there may be tax implications if your lender releases you from paying back the deficiency. In the eyes of the IRS, forgiven debt is taxable income. There are some exceptions to this rule. See the IRS website page on the Mortgage Forgiveness Debt Relief Act of 2007, Ten Facts for Mortgage Debt Forgiveness.
- Deed in lieu of foreclosure—In a deed in lieu of foreclosure, you voluntarily turn over your home to your lender in exchange for your lender releasing you from all mortgage obligations. Make sure to get the release from your lender in writing. Like in a short sale, the amount of forgiven debt may lead to some tax liability. And if there are additional liens on your home, all the other lien holders need to approve the deed in lieu of foreclosure.
As part of your deed in lieu of foreclosure agreement, your lender may also agree to a “cash for keys” deal. In such a deal, your lender gives you a certain amount of money, and you agree to move out by a certain date and leave your home in good condition. Lenders give cash for keys to avoid the time and expense of evicting homeowners and repairing vandalized homes.
Can Bankruptcy Help You Avoid Foreclosure?
Bankruptcy is another option for homeowners hoping to avoid foreclosure. Filing for Chapter 7 or Chapter 13 bankruptcy may delay foreclosure for months or even help you keep your home indefinitely. When you file for bankruptcy, the court orders all of your creditors to stop their collections activities; this is called an “automatic stay.” The automatic stay keeps your lender from going forward with the foreclosure, even if a sale date was already scheduled. There is an exception: Your lender can ask the court to lift the automatic stay. If the court grants permission, your lender would be allowed to go forward with the foreclosure sale.
If you're behind on your mortgage payments, Chapter 7 will delay the loss of your home for a few months, but it won’t bar your home from being sold at a foreclosure auction. In a Chapter 13 bankruptcy, on the other hand, you may be able to keep your home. But only if your income is enough to cover your current mortgage payment as well as an additional payment to make up for all your past due mortgage payments.
Need More Help?
If you need help wading through these loss mitigation options or you need someone to advocate on your behalf, free or low-cost help can be found through the Department of Housing and Urban Development’s website page on Avoiding Foreclosure. Be wary of offers to help you avoid foreclosure that sound too good to be true. For tips on avoiding scam artists preying on desperate homeowners, see the Department of the Treasury's website page on Avoiding Mortgage Modification Scams and Foreclosure Rescue Scams.
