Avoiding Default and Foreclosure

Being underwater on your mortgage isn't a fun situation to be in, but so long as you can keep up with your payments and don't have to sell your home immediately, it isn't a situation that will affect you in a bad way. However, if you are falling behind in your payments, or know that you will soon be in a situation where you may start falling behind in your payments, you should consider discussing the following foreclosure prevention options with your loan servicer:

Loan Reinstatement
You pay the loan servicer the entire amount that is past due, plus any late fees or penalties, by a date you both agree to. This option may be a good one if your problem paying your mortgage is temporary.

Agree to a Repayment Plan
In this situation, the loan servicer gives you a fixed amount of time to make up for missed payments by adding additional funds to each regular payment. This option may be appropriate if you’ve missed a small number of payments.

Loan Forbearance
You can work with your loan servicer to reduce or suspended your payments for a period you and your servicer agree to. At the end of that time, you resume making your regular payments and you make additional payments, either in a single lump sum payment, extra funds with each regular payment, or some combinaton of the two, until you bring the loan current. Forbearance may be an option if your income is reduced temporarily, such as during a short term disability leave. Forbearance isn’t going to help you if you won't be able afford the additional payments.

Loan modification
You and your loan servicer can agree to permanently change one or more of the terms of the mortgage contract to make your payments more manageable. Modifications may include reducing the interest rate, extending the term of the loan, or adding missed payments to the loan balance. A modification also may involve reducing the amount of money you owe on your primary residence by forgiving, or canceling, a portion of the mortgage debt.

Keep in mind that under the Mortgage Forgiveness Debt Relief Act of 2007, the forgiven debt may be excluded from income when calculating the federal taxes you owe, but it still must be reported on your federal tax return. A loan modification may be necessary if you are facing a long-term reduction in your income or increased payments on your mortgage, which may be the case if you have an adjustable rate mortgage.

Before you ask for forbearance or a loan modification, be prepared to show that you are making a good-faith effort to pay your mortgage. For example, if you can show that you’ve reduced other expenses, your loan servicer may be more likely to negotiate with you.

Selling Your Home
Depending on the real estate market in your area, selling your home may provide the funds you need to pay off your current mortgage debt in full. If your loan is already under water, that is if the sales price is less than the amount on the loan, you will either have to pay the difference or make some other arrangement to close the deal.

A sale under these conditions is called a "short sale." This approach is especially good if you are trying to avoid the damaging effect that a foreclosure would have on your credit report. Depending on your expenses related to the sale, including moving expenses to your new home, you may be above water on your mortgage but still come out of the deal with less money in your pocket.

Bankruptcy
Personal bankruptcy generally is a legal procedure that is considered to be the debt management option of last resort because the results are long-lasting and far-reaching. A bankruptcy stays on your credit report for 10 years, and can make it difficult to get credit, buy another home, get life insurance, or sometimes, get a job.

If you and your loan servicer cannot agree on a repayment plan or other remedy, and if you have a regular income, you may want to look at filing a Chapter 13 bankruptcy. In this kind of bankruptcy, the court approves a repayment plan that allows you to use your future income toward payment of your debts during a three-to-five-year period, rather than surrender the property. After you have made all the payments under the plan, you receive a discharge of certain debts. It is even possible that you may be able to keep your mortgage property.

To learn more about Chapter 13, visit www.usdoj.gov/ust; it’s the web site of the US Trustee Program, the organization within the US Department of Justice that oversees bankruptcy cases and trustees.

If you have a mortgage through the Federal Housing Administration (FHA) or Veterans Administration (VA), you may have other foreclosure alternatives. Contact the FHA (www.fha.gov) or VA (www.homeloans.va.gov) to talk about your options.