A short sale is a viable alternative to foreclosure. However, it is important that as a homeowner, you investigate all the available options before arriving at the decision that is deemed to be most favorable. Let’s check out the alternatives:
Renting out the property
This method may work out if you are being transferred due to employment and you don’t want to sell your property already lagging in mortgage payments. So, if you can find rental accommodation, provided the rent is cheaper than the normal rate of rent of your property, it might be successful.
The reality paint’s a different picture. In today’s market, few homes can afford to successfully charge monthly rent that exceeds their monthly mortgage payments. Most homeowners have to settle for “topping up” the mortgage payments as well paying the monthly rent. Homeowners must also consider the miscellaneous expenses that may arise, like repairs during the timeline of renting out.
Renting a property may work out only if the rent exceeds mortgage payments. Also, if you have enough cash flow to take care of the mortgage in the present, until the property value increases enough in the future to make a profit off its sale proceeds.
Refinance
Refinancing is defined as replacing the existing mortgage with a loan that offers more favorable terms. It requires paying off an existing mortgage to create a new one. The catch being- the property used to create the new lien must have enough equity value, and the borrower must meet the minimum income standards and boast of a good credit rating.
The main aim of refinancing is to lower the interest rate, that is, changing the mortgage terms or introducing fixed interest rates instead of flexible ones. A longer term is more attractive to borrowers, as it lowers the monthly payments. However, a shorter term will pay off the loan sooner, saving huge amount of interest overall. Borrowers looking for a long term financial health will opt for the shorter term, as it offers a more stable solution.
You can also use refinancing to combine mortgages. For example, if your property has 2 mortgages, you can combine them to create a new loan. However, refinancing does come at a cost. The estimated expenditure on refinancing falls between 3% to 6% of the outstanding principal on the loan. Fixed costs include loan origination, application, inspection, appraisal, attorney fees etc. and there might be “point fees” amounting to 3% of the loan principle. Also, if you pay off the mortgage early, some loans may charge a “prepayment penalty” comprising of 1 to 6 months of interest payments. For example, if a borrower owes $200,000, their refinancing cost would range between $6000 and $12,000. You need to weight this cost against your eventual savings, to decide if the refinancing is worth doing.
It’s important to remember that, refinancing is not available to borrowers who are underwater with their mortgages as they lack the requisite equity to qualify for a new mortgage. It is also not available to borrowers who have defaulted due to reduced income or increased cost of living.
Loan modification
Borrowers who have failed to qualify for refinancing often try this option. Loan modification signifies any permanent adjustment that is made to one or more terms of a borrower’s existing loan. The aim is to modify the payments so that the borrowers can afford to make them, present them with a fresh start. For example, reducing interest rates, extending loan term etc.
The homeowners choosing this option are usually behind their monthly payment, and loan modification often include an amount to gradually adjust the previous missed payment. So, the updated amount is usually higher than the previous one, exposing the borrowers to a greater risk of defaulting.
In 2009, the federal government had introduced Home Affordable Modification Program (HAMP), a loan modification program to help American homeowners improve their negotiation skills and avoid foreclosure. However, it failed miserably as many of the trial modifications failed to become permanent modifications. For example, homeowners who were successfully paying the modified amounts on time, were denied a permanent modification by their lender, and were instructed to pay the balance amount between the regular and discounted payments instead. Most borrowers failed to afford the new payments and faced default yet again. The tragic aspect of this scenario is that the homeowners attempting loan modification lost valuable time, becoming more delinquent while the property values continued to diminish. They faced the inevitable, that is, foreclosure.
Forbearance
Forbearance is a temporary reduction or suspension of loan payments. A lender may grant forbearance based on 2 factors:
- If the factors influencing the borrower to default is temporary.
- If the borrower didn’t miss any mortgage payments before such default.
Examples of such factors are loss of income due to any medical emergency or reduction in cost due to a natural disaster. A lender may also grant forbearance if the borrower is unemployed.
Forbearance is usually granted for 3 to 12 months. At the end of such a period, the lender will expect all the missed payments, either straight up or through a repayment plan.
Repayment plan
It is defined as a creation of a payment schedule to make up for the missed mortgage payments. Like Forbearance, the lender may approve a repayment plan only if the borrower defaulted due to temporary hardship, that is, unemployment, death in the family etc. The lender would also demand concrete evidence that the borrower can make the sufficient repayments. A repayment plan is added on top of the regular mortgage payments until the borrower pays off the overdue debt. However, it doesn’t require altering the terms of the mortgage.
Deed in Lieu (DIL)
DIL is only adopted as a last resort, when all other avenues of payment have failed. It is also known as voluntary foreclosure, as the homeowner voluntarily transfers the deed of his property to the lender. The basic difference between a DIL and foreclosure is that the owner can avoid the stress of going though foreclosure. To complete a Deed in Lieu, the borrower must hand over the keys of his property to the lender for an inspection. The borrower who opts for a DIL must also acquire a written deficiency waiver from the lender, stating they won’t pursue the borrower for any unpaid balance on the existing mortgage.
Taking no action
It basically signifies doing nothing and waiting for the inevitable, i.e. foreclosure. Not making any mortgage payments, taking any action and not communicating with your lender will eventually lead to foreclosure. Some homeowners may find this option suitable, as they can live in their home until the law-enforcement boots them out. However, it also has a negative side. You will have to bear with constant notices and phone calls, and eventually look for a new accommodation, knowing at some point you will face the boot. The stress or the social stigma, facing potential humiliation in front of friends and families is not everyone’s cup of tea.
The foreclosure process follows fairly set timelines, spanning under 12months. However, you can always look for other options to slow down the inevitable or stop it all together.
Bankruptcy
All the options mentioned till now, except renting out a property, provides more upper hand to the lender. The lender initiates or approves the stipulations, deciding what happens. Bankruptcy is one solution that transfers that power back to the borrower, that is, you can choose it for yourself. However, theoretically, lenders can force you towards involuntary bankruptcy, but that happens in extremely rare cases. Generally, they have no say in your decision if you declare yourself to be bankrupt.
Bankruptcy is the best way to put old debts behind and opt for a fresh start. However, it carries a certain blemish with it. Most homeowners in debt are honest people who are just looking to clear their name and declaring bankruptcy can stop a foreclosure outright. There is a common misconception about bankruptcy that you will lose everything. Although, bankruptcy does allow for exempting assets, including the equity in your family residence, and there are numerous examples where people don’t lose anything at all even after declaring themselves bankrupt.
If the equity in your family residence is below a certain amount, you may be able to keep it. Your home remains outside the deal, you continue to make mortgage payments, while the bankruptcy is used to deal with your other unsecured debts, such as credit card payments and auto loans.
Another big advantage of bankruptcy is that it deals with all the debts, including mortgage debts. It creates a specific plan to deal with them, before wiping most of them out of the picture. So, if you are overburdened with debts and looking to get your finances in order, bankruptcy can prove to be the fastest solution out there.
Choosing the right solution
The “right” solution depends on a lot of intricacies; your financial situation, your lender’s willingness to negotiate etc. So, it’s important you review all the options at hand before deciding on the appropriate plan. Seeking professional financial advice, from accountants, reals estate professionals and attorneys specializing in this sector is highly recommended. Remember, you need to find the solution that suits you the most and be aware of the long-term implications of your choice. For example, if you get rid of your residence through short sale or foreclosure, will you still be responsible to pay back any part of the debt in the future? If your lender forgives some amount of debt, will you need to pay income tax on it? Do your homework, that’s what counts.
Financial troubles and stress go hand to hand and doing nothing won’t make that problems go away. So, it’s crucial you deal with an underwater mortgage. Getting started might prove to be difficult, but it’s about your future and you need to make sure it’s safe and secure.
Another important reason to act is to preserve your credit ratings. Choosing the right option can make all the difference there. For example, you credit score may end up being worse from foreclosure (200 to 300 points) than from a short sale (50 to 100 points). Right now, things may look downhill but in the near future you might want to acquire a car loan or purchase a new house. That’s when the credit rating will come into play. Taking charge of your situation and finding a mutually agreeable solution is the best way to walk out of this mess with dignity.