Should I Take A Bailout Loan To Stop Foreclosure?

If you’re facing foreclosure, you’re likely under a lot of stress. It’s important not to let that stress force your hand and to clearly and carefully assess your options. Two common options are bailout loans and reverse mortgages. A bailout loan is a new loan that helps you get out of default. A reverse mortgage is an advance sale of the equity in your home.

A foreclosure bailout loan might look like the perfect solution at a glance, but it has downsides, too. If you’re considering a bailout loan to stop foreclosure, make sure that you understand your options and their potential impacts on you, your finances, and your family. 

Last-Minute Refinancing

If you fall behind on your mortgage, the past-due balance can keep you from catching up. Even when your financial circumstances improve and you can make regular payments, you may struggle to catch up on the past-due balance fast enough to prevent foreclosure.

In that situation, refinancing may be an option. Usually, with a refinance, the new lender will pay off your old mortgage and you’ll get a new loan in its place. Sometimes, though, the lender will offer you a smaller loan to get you out of default. In that case, you’ll have to continue making your regular monthly mortgage payments, along with the new loan payments. These loans are usually also high-interest loans, which isn’t ideal as interest charges can really add up over time.

Lenders that offer this type of loan often have lower standards than conventional mortgage lenders do. For example, borrowers may only need to have a credit score of 500. By contrast, conventional mortgage companies usually require borrowers to have a credit score of 620 or above. Some government-backed lending programs may require slightly lower credit scores. But, those scores are still considerably higher than the 500 floor set by many lenders offering foreclosure bailout loans. 

Because these loans—often called hard money loans—are based on property value, they are often approved more quickly than a conventional mortgage. But, they come with the following requirements:

• Typically, you’ll need to have at least 40% equity in your home. That means if your home is worth $100,000, you can’t owe more than $60,000. 

• These loans are typically capped at 65% of the value of the property. 

• You’ll likely have to work with a nontraditional lender. Most banks and conventional mortgage lenders won’t offer a new loan to someone who is currently in default or who has a low credit score. That usually means that bailout loans have higher interest rates and less favorable loan terms than ordinary mortgage loans do. 

It’s important to understand that hard money loans are typically short-term loans. This kind of refinancing is not usually a good long-term solution. Pursuing this option can buy you time to rebuild your credit so that you can secure a more traditional mortgage for the longer term. Of course, that requires making payments in full and on time. Otherwise you’ll again face negative credit reporting, fees, and possible default. If you’ve received a loan to cover the delinquent balance rather than a complete refinance, you’ll need to budget for these short-term payments in addition to your ordinary mortgage payments.

Like any industry that serves people in desperate circumstances, the foreclosure bailout loan industry draws scammers. If you’re considering this option, be sure to educate yourself about mortgage refinancing scams and thoroughly research potential lenders before committing to a plan of action. 

Reverse Mortgages

A reverse mortgage isn’t exactly a loan. But you can use a reverse mortgage to bail yourself out of a defaulted mortgage loan. With a reverse mortgage, you pre-sell the equity in your home. In return, the reverse mortgage provider gives you a lump-sum payment, monthly payments, or a line of credit. 

Though the reverse mortgage provider will own the equity in your home, the home is still yours for as long as you live there. When you pass away or move out, the reverse mortgage provider will take possession. Because you have the right to live in the house for the rest of your life, reverse mortgages are typically only available to elderly homeowners. Providers generally don’t want to purchase the equity in a home that they have to wait 50 years to take possession of.

If you’re considering applying for a reverse mortgage, be aware that it may disqualify you from some public benefits, including Medicaid. Many older adults or homeowners who are disabled use Medicaid benefits to cover long-term care. If you qualify for public benefits, it’s a good idea to ask a professional for guidance before you apply for a reverse mortgage.

Home Equity Conversion Mortgage Program (HECM)

The U.S. Department of Housing and Urban Development (HUD) and Federal Housing Authority (FHA) offer the Home Equity Conversion Mortgage (also known as the Reverse Mortgage for Seniors). HECM is the only federally insured reverse mortgage. It is only available through FHA-approved lenders, and only if the following specific requirements are met:

• The homeowner/borrower must be at least 62 years old.

• The homeowner/borrower must either own the home outright or have substantial equity in the property.

• The property must be the homeowner/borrower’s principal residence.

• The homeowner/borrower must not have any delinquent federal debt, including federal taxes and student loan debt.

• The home must meet HUD and FHA flood requirements.

• The homeowner/borrower needs to show that they can pay continuing expenses, such as real estate taxes, insurance, and homeowners’ association fees.

The loan amount cannot exceed the appraised value of the home or $822,375, whichever is less. The homeowner’s age and the current interest rate will also impact the cap on an HECM reverse mortgage. 

Other Options

Foreclosure bailout loans and reverse mortgages are two possible options for avoiding foreclosure and remaining in your home. But, they’re far from the only possibilities. When your home and your finances are at stake, it’s important to fully explore your options. Make sure that you’re making the best choice available. 

Your mortgage loan servicer is required to reach out to you to explore loss mitigation options if you fall behind on your payments. But, there’s no reason to wait for a notice of default to start exploring your foreclosure prevention options. Here are some other common tools that may help you avoid foreclosure: 

Mortgage Forbearance

When you’re under pressure, the simplest solutions might escape you. Though many people qualify for a forbearance, they may not think to call their mortgage servicers to ask for one. A forbearance agreement allows you to skip or reduce a specified number of payments. Of course, you’ll still owe that money. But, depending on your servicer and your circumstances, you might be offered payment options that include:

• Catching up all at once after the forbearance (also called a balloon payment, which is best avoided because it can be nearly impossible to pay off in a lump sum)

• Increasing the amount of your regular monthly payment slightly after the forbearance

• Adding the skipped payments or partial payments and any accrued interest to the end of the loan

You’re not guaranteed a forbearance. But, it is an option worth exploring as it can be the simplest way to resolve the short-term problem of not being able to make mortgage payments due to financial hardship. Granting a forbearance can be good for the lender, too, if it helps you avoid default and get back on track within a few months.

Loan Modification

Instead of seeking out a new loan, you may be able to change the terms of the one you already have. Depending on your situation and your servicer, a loan modification may involve changes such as: 

• Lowering your interest rate or switching from an adjustable rate to a fixed rate

• Extending the term of the loan to lower your monthly payments

• Reducing the principal balance

Each of these options has benefits and downsides. For example, extending your loan may lower your monthly payments. But, it could leave you paying significantly more in the long run. And, if your principal is reduced, you may get a surprise the following year—that forgiven debt may be treated as taxable income. Do your homework before you make a decision.

While there are many for-profit companies that offer loan modification assistance, it is usually not necessary to pay for help. Your servicer can assist you with the loan modification application process. If you need additional guidance or your servicer isn’t helping, you may be able to work with a housing counselor at a nonprofit agency. 

The mortgage modification application process can be slow, so it’s a good idea to reach out to your servicer as soon as you know that you’re going to have trouble making your regular payments for a while.

Short Sale And Deed In Lieu Of Foreclosure

A short sale won’t save your home, but it may be a way to get out from under crippling mortgage debt in a way that may not tank your credit score in the way that foreclosure would. Short sales are particularly useful when real estate values are down and you may be unable to sell your home for a profit because you owe more than it’s worth. In this situation, a lender may agree to allow you to sell the property for less than the outstanding loan balance and settle the debt for the proceeds. 

Because the lender’s lien would otherwise prevent such a sale, this option requires the lender’s approval. Typically, the lender will agree to a short sale only if the purchase price equals or exceeds what they would expect to receive through a foreclosure sale. 

Similarly, the lender may simply agree to accept the deed to the property rather than pursuing foreclosure proceedings (a deed in lieu of foreclosure). As with a short sale, you’ll lose your home, but you’ll also be free of mortgage debt and related legal proceedings and your credit score may not suffer as much as it would if your home was formally foreclosed upon. 

Chapter 13 Bankruptcy

If you’ve fallen behind on your mortgage payments, but have since recovered financially, Chapter 13 bankruptcy may be a good option for you. For example, if you were out of work for six months and missed several payments, you may not be able to quickly bring the loan up to date when you return to work. If your mortgage servicer isn’t willing to let you pay the past-due balance over time, a Chapter 13 repayment plan may be beneficial.

This plan allows homeowners to catch up on their past-due balance with regular monthly payments over 3-5 years while continuing to make current payments as they come due. A court order stops the mortgage servicer from foreclosure and other collections actions while the bankruptcy case remains active as long as:

• The plan is confirmed by the bankruptcy court.

• The homeowner continues to make plan payments on schedule.

• The homeowner makes current mortgage payments on time.

Let’s Summarize…

Bailout loans, also known as hard money loans, tend to have high interest rates. They may also require the borrower to refinance again within a few years. Borrowers should think carefully about taking out this type of loan and investigate the lender because these loans are often scams. 

For homeowners who qualify, a reverse mortgage may be a better option than a high-interest foreclosure bailout loan. But, reverse mortgages aren’t right for everyone. Before making a decision, consider both options. Also consider other possibilities, such as forbearance, mortgage loan modification, and Chapter 13 bankruptcy.