What It Really Means When Something Goes Into Foreclosure
For many homeowners, foreclosure probably conjures up images of the local sheriff knocking on your door to evict you, followed by your worldly possessions spread out across the lawn and your precious home being auctioned to the highest bidder on the courthouse steps. Truth is, those cliches aren't all that far removed from reality. The good news is, though, there are many opportunities to find a solution between missing your first mortgage payment and incurring a devastating home foreclosure.
The reasons why homeowners with a mortgage stop making payments are many. Loss of a job or other income, health issues, divorce, and even rising interest rates on an adjustable-rate mortgage can all cause homeowners to fall behind on their house payments. If this debt situation isn't eventually corrected and the lender doesn't foresee getting repaid the money that you borrowed to make your home purchase, it'll go after the collateral as a last resort.
In the case of a home mortgage, the collateral is the house itself, which the lender will resell at an auction or trustee sale to recoup its loan losses to the highest degree possible. Needless to say, when your home is sold at auction, you'll be required to vacate the property, if not sooner. While each state has slightly different laws governing the home foreclosure process, the overall arch is fairly similar. With that in mind, here's what to expect and what you can do to prevent getting foreclosed on.
Nothing drastic will happen to you right away
Banks are in the business of lending money, not selling real estate. Lenders would greatly prefer you continue paying your mortgage loan rather than going through the time-consuming hassle and legal fees of foreclosing on your home and having to sell it. Therefore, you have to be seriously delinquent before the foreclosure process occurs. A lender won't initiate the foreclosure process in earnest after a single missed payment, or even several missed payments.
Lenders will, however, reach out to a delinquent homeowner, either directly or through a collection agency, to remind them about the missed mortgage payments and perhaps even make suggestions to avoid default. As the timeline of non-payment grows longer, the lender will send a formal notice of default. This typically happens after about three months of not receiving payments.
The notice may also include vital information like how much is currently overdue, including fees, and how long you have to resolve the situation. The homeowner likely won't be the only party privy to the notice of default. It'll likely also be filed with the court system in the form of a "lis pendens," which is Latin for "suit pending."
Don't ignore the preforeclosure warnings
Receiving a notice of default officially kicks off the preforeclosure period. Although it sounds ominous, borrowers still have approximately three to 10 months before losing their homes while the foreclosure process runs its course. During that time, smart borrowers will correspond with their lender to work out a solution.
One way a lender might help borrowers avoid foreclosure on their home is to grant forbearance, a temporary pause in payments that'll allow the borrower to get past an emergency or personal issue. Another avenue for lenders to avoid the costly foreclosure process — while simultaneously helping keep borrowers in their homes — is loan modification. Unlike forbearance, loan modification is a long-term solution that may consist of a lower interest rate, changing from a variable interest rate to a fixed rate, extending the term (duration) of the loan, or a combination of these options. In the end, the methodology for loan modification is to make it easier for an overwhelmed borrower to repay their loan.
In an extreme example of loan modification, during the 2008 housing bubble and resultant Great Recession, some lenders were even willing to reduce the principal amount of mortgages to bring the loans more in line with the newer, reduced valuation of homes. Backed by the federal government, this program ran through 2016 and was called the Home Affordable Modification Program.
Refinance instead of missing payments
Homeowners who are experiencing difficulty making their mortgage payments definitely have a tailwind at their backs in recent years due to rising home prices. Rapidly increasing real estate prices, especially following the COVID-19 pandemic, have made it possible for struggling borrowers to refinance or sell their home in order to resolve a bad situation.
Interest rates on traditional 30-year mortgages closed out 2023 at 6.76%, which is more than double the sub-3% rates available circa 2021. That's the bad news. But the good news is that homeowners with equity built up from making payments for a number of years or homeowners whose homes have appreciated since the time of purchase can still refinance — albeit at a potentially higher interest rate.
For example, if you paid $300,000 for your home that's now valued at $500,000, you can refinance based on the home's new appraised value. That'll provide you a portion of the $200,000 appreciation in cash, which can be used to alleviate whatever is causing your financial distress, like medical bills. If possible, it's best to begin the refinancing process before you miss any mortgage payments. That's because the missed payment will get reported to the credit bureaus, lowering your credit score and your attractiveness as a borrower.
Sell your home to move on
An additional byproduct of the surge in home prices in recent years is that struggling homeowners can often sell their homes to get out of an unsustainable situation. If your home has appreciated to a level in excess of the mortgage balance, you'll even be able to leave the closing table with a check for the difference. Additionally, profit on the sale of your primary residence is exempt from capital gains tax up to a certain dollar amount, provided that some qualifications are met, like living in the property for at least two years.
Of course, the downside to selling your home is that you'll physically need to move, which is not only a hassle, but it can be upsetting for families with social and/or educational ties to their existing neighborhood, assuming they can't relocate nearby. Still, reducing the mounting stress that comes from falling behind on payments and impending foreclosure may be worth the sacrifice.
Finally, even if your house is worth less than you owe on the mortgage, you might still be able to walk away cleanly from the obligation via a "short sale." Appropriately named, a lender-approved short sale lets borrowers sell the home for less money than the lender is owed, though, typically, a borrower must already be in preforeclosure before a short sale will be approved. Although the lender will still lose money with a short sale, it may be a smaller loss than going through the costly and time-consuming legal process of foreclosure, then risking the sale price of the home at auction.
Accept a deed-in-lieu of foreclosure agreement
During preforclosure, some lenders may be willing to accept a deed-in-lieu of foreclosure. Like the name implies, that means that homeowners forfeit their ownership rights to the lender and vacate the property. The lender is then free to sell the property without the hassle, and the expense, of a formal foreclosure process. The benefit to homeowner borrowers is that a deed-in-lieu of foreclosure doesn't look as bad on your credit report as an outright foreclosure does, though it's still somewhat bad for your credit score, to be sure. Also, before entering into a deed-in-lieu of foreclosure agreement on your home, make sure the lender isn't expecting to be reimbursed for any losses it incurs by selling the property. If you're unsure how to proceed, consider consulting a knowledgeable attorney.
The bottom line when it comes to foreclosures is that, similar to owing income taxes, it's never in your best interest to ignore an impending foreclosure, hoping it'll go away. It won't, and the sooner you open a dialogue with your lender, the better. Note, besides hiring an attorney who specializes in defending against foreclosures, the United States Department of Housing and Urban Development also operates programs to help homeowners avoid foreclosure.