In a career twist I would not have predicted, I have somehow become somewhat of an expert on the subject of mortgage refinances, loan modifications, and foreclosures over the last two years. Anyhow, odds are that you or one of your family members or friends is facing foreclosure on their home right now. I figured I could write some general advice about this subject in the hopes it might help someone.
Here is a scenario:
An LDS family in California is facing foreclosure. They bought their home at the height of the market in 2005 and now the home has dropped in value by more that $200,000. So between their first and second mortgage they owe $200,000+ more on the home than it could sell for right now. In the meantime the income of this good family has significantly decreased with the contracting U.S. economy. The upshot is that this family has no chance of being able to make their current mortgage payments over the long run. They made the full payments as long as they could, draining most of their savings in the process but now are up against the wall.
This is a fairly common situation these days. My advice to this family would be as follows:
1. Stop paying the second mortgage immediately. The second mortgage holder will never foreclose on this family. The reason for this is that when a house forecloses the proceeds from the sale of the home must pay off the first mortgage in full first and anything that is left over pays off the second mortgage. When a house is deeply upside-down/underwater (worth less than the mortgages) the second mortgage holder has no incentive to foreclose. Foreclosing costs the bank/servicer thousands of dollars in legal fees to begin with so a second lien holder would get nothing from foreclosing but a legal bill. Of course missing the mortgage payments on the second loan will hammer the credit score of the borrower for a while but there are a lot worse things than a lowered credit score. If the income situation improves over time the family could get back on track with the second mortgage if they manage to stay in the home.
2. Seek a loan modification on the first mortgage. A mortgage is simply a contract between a borrower and a bank. The bank gives the borrower a loan against some collateral (the home in this case) and if the borrower doesn’t pay the loan the bank takes the collateral. But the bank can change the terms of the agreement if it chooses to. As I mentioned, foreclosing is a costly venture for banks and even the first lien holders aren’t always anxious for the 6-12 month legal process a foreclosure requires. Further, if the lender can keep the borrower in the home long enough for housing prices to bounce back it might make more sense to foreclose later rather than sooner — particularly when the first mortgage is underwater. For those reasons banks sometimes will modify the payment terms for borrowers and give them something like a 5-year interest only payment at 3-4%. In such cases the bank buys time for the market to recover and the borrower avoids getting evicted for at least 5 years. (Note: Contact your lender/servicer directly for a loan modification. It rarely makes sense to pay thousands of dollars to a third party company to help you secure a loan modification with your own bank.)
Of course if a borrower still has equity in the home the bank has much less incentive to modify the loans. If the bank can foreclose and get all of their money back now they often choose that route. If the home is worth more than the mortgages against it the borrower is usually better off selling and downsizing. Also, banks are far more apt to entertain loan modification requests when they know the applicant is not bluffing so it is not uncommon for people who are several months late on their mortgages to get more attention from the bank than someone who is on time.
3. Don’t be intimated by the barking banks. Banks are pretty good at barking loudly and scaring borrowers. In many cases it takes a bank 6-12 months to actually foreclose and evict a family from a home. In cases where there have been income losses that often can provide 6-12 months for the borrower to seek a loan modification. Further, it can give the family 6-12 months of rent-free housing while this process is happening. If things go well with the loan modification efforts the family need not move at all. If the loan modification does not happen the family can still remain in the home for some time even after the bank officially puts the home on the auction block. Basically when the Sheriff gives a family 72 hours to vacate is the official deadline. Dealing with a barking bank can be very uncomfortable but if it saves a family thousands per month while they prepare to rent a place that can make a big difference when it comes to getting back on one’s feet.
Of course every state is different so in some situations declaring bankruptcy may be needed as well. Seeking competent legal advice is always best when dealing with bankruptcy questions.
The Big Picture
Remember, there are much worse things than dealing with a foreclosure. One of those is not having enough money to buy food or gas. The truth is that if you do go through a foreclosure the first goal should be to get back on your feet financially afterward. Yes you will have to rent for a few years but renting has some real advantages too. If all the bills get paid going forward one can become eligible for a mortgage in 3-4 years so a foreclosure is certainly not a life sentence when it comes to home ownership.
Job losses and foreclosures are abounding in 2009 and will probably continue to mount over the next year. May you avoid these kinds of troubles. But if you are among the millions of people facing these issues I hope this general advice helps and I will be happy to answer any other questions that come up in the comments.