The unstable environment of a bad economy can leave homeowners dreading how low their home values will go. Zillow, an online real estate marketplace, revealed that people who purchased homes when most markets peaked had the highest rates of negative equity when the real estate market collapsed. This occurs when the home value is less than the original mortgage amount, and is also known as an "underwater mortgage." This problem, along with other financial setbacks such as a job loss or a medical emergency, can leave many people at the brink of foreclosure. Homeowners can maneuver through the troubling times by considering the following "dos" and "don'ts."
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Don't "Buy and Bail"
Many people will honor their mortgage obligations. However, those faced with negative home equity and homeowners suffering from a job loss and debt can profit from "buy and bail" scams. This occurs when the value of the home has dropped, and the borrower makes payments but notices a bargain at another home. This person applies to purchase the new home and may mislead the broker into thinking he/she plans to make the old home a rental. Once the process is complete, the borrower will let the initial home go to foreclosure.
Fannie Mae, one of the leading purchasers in residential mortgages, found that the number of first time owners and borrowers who fail to pay their mortgage shortly after purchasing a second property increases during a housing pullback. The government cracked down on this scam by making the underwriting phase of the loan approval stricter; FHA-insured mortgages on or after September 19, 2008 could not consider rental income from the vacated home. Exceptions were made for people relocating or transferring for job purposes, and to those who had a loan-to-value ratio of 75% or less. (Find out more about FHA loans in Understanding FHA Home Loans.)
Don't Ignore Lender's Mail or Calls
Believe it or not, lenders are willing to work with a struggling homeowner and want to avoid the expense of a foreclosure. The costs to foreclose on a home lender have generally been greater than $50,000, or between 30-60% of the outstanding loan balance. Lenders have often had a tough time reaching borrowers though, and borrowers who don't reach out may miss an opportunity to save their homes. Payment options are available to help late-paying borrowers, but many people are not aware that they had these choices, a Freddie Mac/Roper Public Affairs and Media survey found. In the study, one in four of these borrowers wouldn't accept their lenders invitations to talk about the options because they didn't think it was necessary to call, or they thought the servicer couldn't help.
Don't Slack on Payments
Strategic defaulters also wreak havoc in down markets. These borrowers have the money to pay their mortgage, but don't. During the Great Recession, 26% of existing defaults were strategic, a July 2009 National Bureau of Economic Research paper revealed, and people who knew others that defaulted were 82% likely to do the same. Those with strong credit ratings were 50% more likely to strategically default than those with lower scores.
Whether a strategic defaulter or not, late mortgage payments can destroy credit. The damage to a credit score doesn't stay too long when payments are 30 or 60 days behind. Fall behind more than 60 days, however, and this becomes a severe offense.
- Loan modifications allow homeowners to re-establish their loans by making one or more changes to terms, in an effort to ease monthly mortgage payments. The Making Home Affordable Program of 2009 included the Home Affordable Modification Program (HAMP), which enabled struggling homeowners to pay their monthly mortgage payments. Such programs are intended to find a mutually beneficial solution, which works for the lender and the homeowner.
Short sales occur when the sale of the home is less than the balance owed on the mortgage, and the mortgage lender is willing to accept the payoff. For the most part, the transaction can be a win-win situation. It helps struggling underwater borrowers avoid foreclosure, and the lender minimize costs because the property is not a foreclosure. The sale has less of an impact on the homeowner's credit score than a foreclosure would. (Learn more about short sales in Short Sales And Foreclosures: When It's Time To Move On.)
- Deed in-lieu of foreclosure allows homeowners experiencing a severe financial hardship to hand over the deed or ownership of the property in exchange for the lender's agreement to cancel the loan. However, it's not that easy if you have second or third mortgages, home equity loans or tax liens against your property. This option also takes a negative hit against your credit rating, but not as hard as a foreclosure.
- Bankruptcy can hold off a foreclosure. Chapter 7 bankruptcy, which gets rid of most debts, allows for an automatic stay. This is a temporary order that provides some relief from both the unsecured creditors and the lender attempting to collect money. The Chapter 13, which has also been known as "save a home bankruptcy" allows the homeowner to work out a repayment plan with the creditors. In order to prevent abuse, Chapter 7 bankruptcies are only available to those consumers in dire situations. Also, prepare for court and attorney fees, and for the bankruptcy to stay on your credit report for several years. (Find out more about declaring bankruptcy in What You Need To Know About Bankruptcy.)
Contact a Local Credit or Home Ownership Counseling Agency
Watch out for companies that try to mitigate between you and the lender. Stay with reputable organizations, so you aren't scammed, such as the Department of Housing and Urban Development (HUD) for government sanctioned counselors. Also, check with the National Foundation of Credit Counselors or the Homeownership Preservation Foundation.
Stay on top of your mortgage payments and seek help as soon as you think you may fall behind. Seek out help from reputable counseling organizations to avoid scams, and talk with your lender about your difficulties to determine what arrangement can be made. (For additional reading, take a look at Saving Your Home From Foreclosure and Homeowners, Beware These Scams.)