4 Things To Know About Defaulting on Your Mortgage

Many Americans dream of becoming homeowners. Most homeowners don’t have the money to purchase a home outright. They make a down payment on the purchase price of the home and borrow the rest from a mortgage lender. Mortgage debt is one of the most substantial debts that Americans take on. Sometimes, borrowers default on their mortgages, even though they are hard-working. Taking on a mortgage just isn’t an easy burden to bear. 

What Is a Mortgage Default and How Does It Happen?

Borrowers who need to borrow money to purchase a home must apply for a mortgage loan. This is part of the mortgage origination process. The borrowers will have to provide their lender with financial information so that the lender can determine whether the borrower can afford to make the monthly mortgage payments required per the terms of the loan. 

When the lender approves the loan, the borrower will have to sign the mortgage loan acknowledging that they agree to the terms of the contract. The mortgage document will specify under what circumstances a default will occur under the mortgage loan. The mortgage contract will also state what the lender’s rights are if the borrower defaults on their mortgage. 

Typically, a mortgage default occurs if the borrower misses payments, fails to pay real estate taxes, or fails to pay for homeowner’s insurance. A mortgage default could occur if the borrower transfers the title to a new owner without the consent of the lender. Default terms vary depending on the loan type and mortgage contract. 

During the financial crisis in 2008, mortgage default rates soared. Mortgage lenders had approved loans for people who could not afford the payments. Some mortgage lenders didn’t even require borrowers to show financial documents during the origination process. As a result, many borrowers couldn’t keep up with the payments and lost their homes to foreclosure. 

Unlike a credit card, payment of a mortgage loan is secured by the home. This means that if you fail to make mortgage payments, the lender can foreclose and sell your home to satisfy the balance of the loan (as much as possible) with the sale proceeds. By contrast, if you fail to miss a credit card payment, you’re usually not at risk of losing your home or any property. 

What Happens if I Default on My Mortgage?

Borrowers who default on their mortgage are charged various fees. These fees add up quickly and the default may hurt your credit score. You’re also at risk of losing your home if you default. The mortgage servicer or the company that services your mortgage loan will charge you a late fee if your mortgage payment is late. On top of late fees, you may be charged fees related to the default. These include fees for property inspections, maintenance expenses, and foreclosure costs. 

The mortgage servicer will notify the three credit bureaus that you missed payments on your mortgage. This will negatively affect your credit score. Even one late payment can affect your credit score. Checking your mortgage loan account is important to see if you’re being charged any fees that you shouldn’t be charged. You will receive notice from the mortgage servicer if you miss a payment. 

If you miss several payments, the mortgage servicer may notify you that they intend to accelerate the loan unless you make up the missed payments. Under the terms of the mortgage loan, if you are in default, the lender has the right to accelerate or call the total amount of the loan due. Once the mortgage loan is accelerated, they will likely start a foreclosure lawsuit against you to sell your home. 

Typically, lenders wait until 4 payments are missed before the loan is accelerated. This number may change depending on the lender. Also, the housing market will affect how soon a foreclosure action is brought. If the courts are backlogged with foreclosures, the lender may wait longer than usual before they’ll start a new foreclosure action.

Time-Frame of Mortgage Default

• The mortgage contract usually gives the borrower a 15-day grace period to make a late mortgage payment. If the mortgage payment is made within this time, you’re fine. If the payment is not made, a late fee will be charged and the credit bureaus may be notified that your payment is past due. 

• After a second payment is missed, the loan is delinquent. Depending upon the terms of your loan, you may be in default after only two missed payments. 

• A letter will be sent to the defaulting borrower giving them 30 days to make up the missed payments or the lender will accelerate the loan.

• After 30 days, a defaulting borrower will face acceleration and - potentially - a foreclosure action.

What Is a Foreclosure?

The foreclosure process varies from state to state. The lender seeks to sell the home in the foreclosure process to satisfy the outstanding balance due. Under federal law, lenders have to wait 120 days before foreclosing on a home. During the coronavirus pandemic, the federal government has placed a hold on the foreclosure of homes that have mortgages insured by the Federal Housing Authority (FHA) or backed by Fannie Mae or Freddie Mac until June 30, 2021. 

In some states, the foreclosure process is judicial, which means a lawsuit needs to be started before a lender can foreclose on a borrower. Other states recognize non-judicial foreclosures, wherein the mortgage document gives the lender the power to sell in the event of default without first initiating a formal lawsuit. If the lender is successful in the foreclosure, they will sell the home at auction. 

If the foreclosure sale price is less than the outstanding balance of the loan amount or the amount you owe (including late fees, interest rates, attorney fees, and sale cost), the mortgage lender can sue you for the remainder of the money owed. This is called a deficiency balance. Having a deficiency balance on your credit history can lower your credit score significantly and may result in a wage garnishment to collect the deficiency judgment.  

How To Avoid a Mortgage Default

Borrowers looking to avoid a mortgage default after experiencing a financial hardship should talk to their loan servicer about their options. Figure out if your financial issue is short-term or long-term because that will affect your best options to avoid defaulting on the mortgage loan. The following approaches may be worth considering:

Forbearance Agreements 

If you’re having short-term money issues, a forbearance agreement may allow you  to avoid foreclosure. A forbearance agreement is an agreement between the borrower and lender where the lender agrees to pause the borrower’s obligation to make mortgage payments or reduces the amount of the payment for a short time. The period is usually three to six months. 

During this time, the lender agrees to give up or “forbear” its right to start a foreclosure action. At the end of the forbearance period, you will be required to make up the missed payments while keeping up with the regular mortgage payments. You will need to enter into a repayment plan with the mortgage servicer to repay the missed payments. The repayment period may vary depending on the lender. They may require one lump sum payment or may allow you to cure the missed payments over a period of time. 

Federal Programs Offer Foreclosure Help

The CARES Act requires that most mortgage servicers provide forbearance to mortgage borrowers who have experienced a coronavirus-related financial hardship. This Covid hardship forbearance applies to federally back and federally sponsored mortgages including HUD/FHA, VA, USDA, Fannie Mae, and Freddie Mac loan agreements. 

Borrowers need to request forbearance from the lender or the mortgage servicer. They have a right to receive a pause or reduction on their loan payment from certain mortgage servicers for up to six months. You may request an extension of the forbearance period from a mortgage servicer. The forbearance period can be extended an additional 180 days by some lenders. Affordable plans to make up the missed payments may be available. 

Loan Modification

If you’re experiencing a long-term financial hardship, you may consider a loan modification. A loan modification changes the terms of the loan document by lowering the monthly payment. Missed mortgage payments will be added to the total amount that you owe. The loan’s interest rate may be lowered, and the term may be extended.

Refinance the Mortgage

To apply for refinancing, you need to be current with your mortgage payments. A refinance replaces the old loan agreement with a new loan document. The terms of the new loan agreement may have a lower interest rate and the term of the loan may be different. Your credit score will play a large part in determining whether you’re able to refinance your loan with better terms.

Bankruptcy

Bankruptcy is also an option. In most cases, filing for bankruptcy will stop a foreclosure. Filing for Chapter 13 bankruptcy relief may help a homeowner save a home that is in foreclosure. A homeowner can keep their house via the Chapter 13 process and pay back the missed mortgage payments over time through a plan. The homeowner will also have to keep up with their regular mortgage payments to the lender.  Loan modifications may also be available through the Chapter 13 bankruptcy process. 

A Chapter 7 bankruptcy is a proceeding wherein assets which you can’t exempt may be sold by a trustee to pay back your creditors. If you’re behind on your mortgage but you want to keep your home, Chapter 7 may not be the best bankruptcy option for you. It delays a foreclosure but doesn’t give you a way of catching up on missed payments like a Chapter 13 filing does. Since there are pros and cons for each type of bankruptcy, it’s never a bad idea to schedule a free consultation with a bankruptcy lawyer in your area to explore your options.  

Sell Your Home and Short Sale 

You could hire a real estate broker to sell your home. From the sale proceeds, you can pay off the mortgage. If you can’t sell your home for more than the total amount due on the mortgage, you may contact the lender to see if they will accept less than the mortgage balance. This is called a short sale. 

In a short sale, the lender may hold you responsible for the amount you owe under the loan document minus the money the lender received from the sale of the house. This is similar to the deficiency balance that can result after a foreclosure. As part of the short sale, you can negotiate with the lender to waive the deficiency. If the mortgage lender waives the deficiency after a short sale, you may owe income taxes on the debt that has been forgiven. 

Deed in Lieu of Foreclosure

A Deed in Lieu of Foreclosure happens when the lender agrees to allow you to transfer ownership in the property to the lender to satisfy a loan and avoid a formal foreclosure. 

There are options available to you if you can’t make your mortgage payments. It’s important to be proactive to see what might work for you. Simply walking away from your mortgage will leave a lasting mark on your credit report. Taking action may help reduce what you owe to the lender. 

Let’s Summarize...

Taking out a mortgage is a big commitment. When you understand how a mortgage default happens and the consequences of a loan default, you may be able to avoid a default or minimize the negative impact of a default. If you’re having difficulty making your mortgage payments, contacting the mortgage servicer to work out a solution is a good idea. You’ll want to have a plan to deal with a delinquency before it snowballs into mortgage debt that becomes unmanageable.