If you have reached the point where you can no longer afford to make your mortgage payments, you have a number of options:
Do Nothing/Sit & Wait (a “Planned Foreclosure”)
If you stop paying your mortgage and take no other action, the lender will commence or continue the foreclosure process. Your home will be sold in a public foreclosure auction and the lender will then evict you from the property. Your credit will show the foreclosure and you will be required to report the foreclosure on all future credit applications. If you have a foreclosure on your record, you will not be able to get another mortgage from most lenders for a period of 5 to 7 years. Also, if you are evicted from the home, your ability to rent will be seriously affected.
Doing nothing is almost always a very bad idea. However, believe it or not, there are situations where sitting and waiting for the foreclosure to take place (i.e. a “planned foreclosure”) is the best option. ONLY A REAL ESTATE ATTORNEY CAN MAKE THIS DETERMINATION. That’s why it is crucial to have a broker who is also an attorney on your team. Contact us today to discuss this issue.
If you have equity in your home (i.e. the value exceeds the mortgages), you might be able to get a new loan to pay off the current loan that is giving you trouble. This option will only help if current interest rates are substantially lower than the interest rate on your mortgage. Additionally, some borrowers have interest-only or negative amortization loans which have artificially lowered payments. A new loan, which probably would not have this feature, will be of little help to a borrower in distress. Finally, most borrowers who are having difficulty paying their mortgage are also victims of the severe decline in real estate values and simply don’t have any equity in their home. A refinance is not available to those borrowers.
If you are at least 62 years old and have equity in your home, you may be able to get a “reverse mortgage” which would allow the current loan to be paid off without having to make future payments. In addition to all the difficult issues raised in a regular refinance, a reverse mortgage actually requires more equity in the home because certain loan-to-value limitations are more strict. Therefore, both refinances and reverse mortgages are available in very limited circumstances and are not viable options for the vast majority of borrowers.
If you are facing a temporary hardship that you expect to recover from quickly, your lender might be able to forgive or defer certain penalties and fees in order to allow you to recover and eventually re-commence making your regular payments. In some cases, the lender will provide a suspension of payments for some period. However, your payments can actually increase after you have recovered from your hardship because you will need to “catch up” from the period your loan was in forbearance. You will need to document your hardship and be able to prove that you expect to fully recover at some point. For borrowers facing a long term hardship, a forbearance is simply not an option.
Loan modifications have been big news (not all good) over the past few years as the government instituted the Home Affordable Modification Program (HAMP). Although HAMP has thus far been a complete failure, it was intended to provide financial incentives for lenders to lower interest rates, extend maturity dates and reduce principal for troubled borrowers. The availability of a loan modification is so limited that less than 25% of borrowers qualify (although the lenders are more than happy to take partial payments during the “trial period”). More troubling is that of those borrowers who actually received a loan modification, more than 60% re-default within 1 year.
One of the big problems with a loan modification is the two-part test that lenders must complete to qualify for the government incentives. This is complicated and convoluted, but it’s what you need to know before considering a loan modification.
- Front-End DTI: First, to qualify for HAMP, the borrower’s current payments for housing debt (principal, interest, taxes, insurance and association dues) must be “unaffordable” which means that they exceed 31% of the borrower’s gross monthly income. This is known as the “Front-End Debt-to-Income Ratio.” This is usually not a big hurdle because most borrowers in financial trouble are paying well in excess of that 31% Front-End DTI. However, some borrowers believe they need to show the lender that they have NO income. If the borrower tells the lender they have no income at all, he or she fails this first test because the lender needs to be able to show that a loan modification will lower the Front-End DTI to at least 31%. If the borrower has no income (or if the borrower artificially decreases his or her income), the lender simply can’t do anything with that borrower. Alternatively, some borrowers already pay less than 31% of their gross income toward their housing debt, but have so many other bills that they can’t afford the mortgage payment. These borrowers also fail the Front-End DTI test because they are already under the 31% threshold. So, as you can see, the borrower has a narrow window between making too much money and not making enough money, within which the lender could provide an adjustment to the mortgage (lower interest rate, extend term or reduce principal) that would take the loan from unaffordable (i.e. greater than 31% Front-End DTI) to affordable (i.e. equal or less than 31% Front-End DTI). However, the evaluation doesn’t end here: This is only the FIRST PART OF THE TWO-PART TEST.
- Net Present Value (NPV): Next, the lender must determine whether it will suffer a greater loss by providing a loan modification as compared to simply foreclosing on the home and selling it. The lender must figure out which option (modification vs. foreclosure) provides the highest ‘Net Present Value’ to the lender. In both a modification and a foreclosure, the lender eventually recoups some of the money that was lent to the borrower. In a loan modification, the lender will receive monthly payments which include principal and interest (albeit, at a lower interest rate than originally contemplated) over a period of 30 or 40 years. An accountant can look at that stream of 360 (or 480) payments and figure out what is it worth in “today’s” dollars (that’s called the “Net Present Value” of a series of payments). Alternatively, in a foreclosure, the lender will end up selling the property, either at a public foreclosure auction or as an REO (bank ‘real estate owned’), and, after paying the foreclosure and sales costs, will have a lump sum of money which it can (hopefully) re-lend to a new borrower. Again, an accountant can figure out how much money the lender will receive as a Net Present Value. At that point, it becomes a simple mathematical calculation to determine whether the lender gets more money through a loan modification or by way of a foreclosure. That’s the Net Present Value Test. Here’s the problem for a borrower: If the lender has to significantly reduce the interest rate, or extend the maturity date of the loan, or even reduce principal, all in an effort to comply with the Front-End DTI test above (that 31% target), it becomes MORE LIKELY that a foreclosure will provide a greater recovery than a loan modification. If so, the lender cannot approve the loan modification and must foreclose and sell the property. It is this little known NPV Test that kills most loan modifications, and the borrower is not told why they don’t qualify.
A loan modification is not as clear cut as all those TV and radio commercials make it sound. There are ways to counter the result of the NPV Test. A skilled negotiator can actually make a difference, but more often than not, a modification is SIMPLY NOT WORTH IT to the borrower. You must take a very close look at the numbers before you waste time and money attempting a loan modification. Additionally, YOU SHOULD NEVER PAY ANYONE AN UPFRONT FEE FOR A LOAN MODIFICATION (CLICK HERE FOR THE DEPARTMENT OF REAL ESTATE WARNINGS ON LOAN MODIFICATIONS). The failure rate is so high, that you are almost certainly throwing money away.
Please contact us so we can explain the TWO PART loan modification test in more detail and how it applies to you and your mortgage. We do not charge for this consultation.
Deed in Lieu of Foreclosure
If you can’t afford the mortgage payment and you can’t refinance or get a loan modification, you might consider a deed-in-lieu of foreclosure (a “Deed-in-Lieu”). In a Deed-in-Lieu situation, you agree to transfer title to the lender and turn over the property instead of forcing the lender to go through the foreclosure and eviction process. This almost NEVER happens in our market (Orange County, CA). The issue with a Deed-in-Lieu is that the lender receiving the Deed-in-Lieu takes the property subject to all other liens and encumbrances (even if those liens and encumbrances were subordinate to the loan). That means if there is a second loan on the property or outstanding judgments, the lender holding the first loan would take the property with those items still outstanding and as active encumbrances on title (which could then foreclose on the first lender). No lender would ever agree to that situation. Therefore, you either need to pay off all those liens or get their agreement to release their interest. The chances of that occurring are infinitesimal.
Bankruptcy is not really an option to address the foreclosure because the foreclosure (and eviction) would still occur after the borrower receives a discharge of the debt. With regard to the foreclosure, Bankruptcy only delays the inevitable. Borrowers should be very careful with filing bankruptcy: this is a serious financial and legal decision that can’t be undone. You should have the advice and counsel of an experienced bankruptcy attorney (someone with more than 10 years experience). You should also speak with a skilled real estate attorney to determine what other options are available. A final note on bankruptcy: Once you have your discharge, you still have the ability to address and negotiation the foreclosure and eviction with your lender. You can cooperate with your lender post bankruptcy in order to limit the negative effects of the foreclosure and eviction procedures. A short sale is probably the best option at that point. Although bankruptcy has serious negative effects on your credit, adding a foreclosure and eviction only makes things much worse. We are here to discuss your post bankruptcy options, at no cost to you.
Short Sales have become the most popular and most successful alternative to foreclosure. A short sale occurs when your lender(s) agrees to the sale of your home for an amount less than the outstanding mortgage balance (the sale is “short” of the payoff). Your lender’s approval is required because it has a lien on your property that must be released to allow for the transfer to the buyer. In a “regular” sale the mortgage would be paid in full and the lien would be released, but in a short sale, there isn’t enough money to pay off the mortgage. Therefore, without approval from the lender to release the lien “short” of the full payoff, the sale wouldn’t be possible. For more information, see our SHORT SALES SECTION