3 Foreclosure Alternatives: What to Do Before Your Mortgage Goes Underwater

Maybe you’ve missed a couple of monthly mortgage payments. Maybe a notice of default from your lender is looming right now. You understand the severity of the situation, but what most homeowners don’t know is that foreclosure is not the only option you have when you’re no longer able to afford your house.

The first step for anyone in risk of foreclosure is to get in contact with your lender. This shows that you are aware of the problem and committed to finding a solution—and trust us, that will go a long way. The earlier you reach out, the greater shot you have of amicably rectifying the problem.

After you speak with your lender, your lender will lay out your options, including the foreclosure alternatives that you might be able to take advantage of. Let’s take a closer look at some of the alternatives so you—and your credit history—don’t suffer the ultimate blow.

1. Standard sale or rental

If your home is currently valued at more than you owe and if you are up to date on your mortgage payments (but you anticipate that paying your mortgage could become a problem), you can hold out as long as possible for a buyer.

You can also try to rent out the home to cover the mortgage payments until the house sells, says Carolyn Rae Cole, a Realtor® with Nourmand & Associates. In the end, virtually all homes eventually sell—it’s just about pricing.

2. Short sale

When a home has fallen in value and is priced so low that there isn’t enough equity to cover the mortgage, you might have the option to conduct a short sale. It’s also known as going “underwater.” This means the lender agrees to accept less than the amount the borrower owes through a sale of the property to a third party.

A short sale works like this: A specialist brokers a deal with the mortgage lender to sell the home for whatever the market will bear. If the amount of the sale is for less than what’s owed on the mortgage, the lender gets the money from the sale and relinquishes the remaining debt. (This means you won’t owe anything else.) In a short sale, the lender usually pays for the seller’s closing costs. A traditional sale takes about 30 to 45 days to close after the offer is accepted, whereas a short sale can take 90 to 120 days, sometimes even longer.

Sellers will need to prove hardship—like a loss of primary income or death of a spouse—to their lender. In addition to explaining why they’re unable to make mortgage payments, sellers will have to provide supporting financial documents to the lender to consider for a short sale.

3. Deed in lieu of foreclosure agreement

A deed in lieu of foreclosure is a transaction between a lender and borrower that effectively ends a home loan. Essentially both parties agree to avoid a lengthy foreclosure proceeding by the borrower voluntarily turning over the home’s deed to a lender, says professor David Reissof Brooklyn Law School
. The lender then releases the borrower from any further liability relating to the mortgage. However, if the property is worth significantly less than the outstanding mortgage, the lender may require the borrower to pay a portion of the remaining loan balance.

You might be eligible for a deed in lieu if you’re experiencing financial hardship, can’t afford your current mortgage payment, and were unable to sell your property at fair market value for at least 90 days.

Bottom line: This agreement is a negotiated solution to a bad situation—borrowers who have fallen behind on their payments are going to lose their house and the lender is not getting paid back in full.

Here are a couple of rules of thumb on dealing with this extremely unfortunate situation:

Go into foreclosure only as a last resort

Many distressed homeowners proceed with the foreclosure process often without being fully aware of the short sale option. But the truth is, banks don’t want the expense and hassle of a foreclosure. It can cost them thousands of dollars to take a home through the process and will force them to report the house as a “non-performing asset,” which can reduce the amount of money they have to loan out to other people.

Foreclosures can range from bad to worse depending on whether you live in a nonrecourse state.

“In a nonrecourse state, if the bank forecloses and doesn’t recover all of its money, it can’t come after you for the difference,” says Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage.”

In a recourse state, you’ll owe the bank the difference between the foreclosure price and the amount you owe on your mortgage.

How short sales and foreclosures affect your credit history

In both short sales and foreclosures, the delinquent mortgage will negatively affect your credit rating. But short sellers avoid having a “debt discharged due to foreclosure” on their credit reports—something that could reduce their credit score by over 250 points! You might also have to wait up to several years to requalify for a mortgage at a reasonable rate.

Short sales, however, show up on credit reports as a “pre-foreclosure in redemption” status and result in a credit score reduction of 100 points or less. People who successfully complete a short sale might also qualify for a mortgage at a reasonable interest rate in as little as 18 months.

Please feel free to contact us for a confidential review of your situation. We believe it is best to know your options before you make a decision.

Article by Margaret Heidenry