Here’s a look at your main alternatives when you think foreclosure is on the horizon. I’ll talk about these scenarios in detail later. For now, just try to get an idea of what you’re dealing with.
 


Reinstate Your Mortgage


If you have enough cash, you can “reinstate” your mortgage by making up all the missed payments plus fees and interest the lender charges you. Your state’s law will probably give you a certain amount of time, after the lender gives you notice that the foreclosure is beginning, in which you have a legal right to reinstate the loan this way. (You can check your state’s rule in the appendix.) 


For example, in California you have the right to reinstate your loan for three months after the lender mails you a notice of default. After that period ends, if you haven’t negotiated a workout, the lender can and usually does accelerate the loan (notify you that it is declaring the entire amount due immediately) and send you a notice of sale, telling you that the house may be sold in 21 days.


In some other states, the lender may accelerate the loan as soon as you fall behind in your payments, and the law does not give you an opportunity to reinstate. But more and more lenders are not eager to accelerate the loan and push ahead with foreclosure; they would prefer to work something out with you.


If you have enough money to be considering reinstatement, you can probably also negotiate something with the lender. Keep in mind that most lenders don’t want to foreclose—it’s a hassle for them, especially these days when house prices have fallen and banks don’t want to be saddled with real estate that may be hard to sell.


Negotiate a Workout 


As mentioned, you should start with a HUD-approved housing counselor and a visit to www.makinghomeaffordable.gov. (See Ch. 4 for more on these resources.) With this assistance, you may be able to get:


• temporary relief from having to make your monthly payments (forbearance)

• a plan to make up your missed payments (at the end of your mortgage or on top of your current payments within a specified period of time)

• a lower interest rate—and as a result, lower monthly payments, or

• a reduction in your principal loan balance.


Even though you can negotiate directly with the servicer, it’s always worth talking to a counselor. Their services are free, and they will help you explore possible remedies and negotiate a workout with your servicer or lender. 


You may have even more workout options available to you if your loan is owned, insured, or guaranteed by a government agency such as Freddie Mac, Fannie Mae, Federal Housing Administration, HUD, VA, or the Rural Housing Service. In fact, mortgages insured by the VA or the Federal Housing Administration (FHA) do not qualify for modification under the Home Affordable Refinance or Home Affordable Modification programs.


Refinance


If you can refinance at a better rate and pay off your old loan, you can start fresh. Unfortunately, refinancing is tough these days unless you have equity in your house and the home value curve in your community is trending up rather than down. Of course, if your mortgage is owned or controlled (through securitization) by Fannie Mae or Freddie Mac and you qualify for a refinance under the Home Affordable Refinance program, your refinancing worries are over. (See Ch. 4.) 


As mentioned, the Hope for Homeowners Act of 2008 provided massive funding for the purpose of converting eligible variable-rate mortgages into 30-year fixed loans insured by the Federal Housing Administration. However, whether or not you will be able to refinance your loan under this program will depend on your lender—for whom the program is completely voluntary. And there’s the rub. In order for you to get refinancing under this program, your lender must agree to cash out the existing loan at 90% of the home’s current appraised value. For example if your loan is for $300,000 and an appraisal puts the home’s value at $200,000, your lender must agree to cash out the loan for $180,000 (90% of the value).


Why would a lender voluntarily reduce the size of the loan? The idea is that the lender will be better off cashing out your loan at 90% of its appraised value rather than having to go through the foreclosure process, which may in the end generate even a larger loss. Also, an amendment to the Making Home Affordable program and legislation currently pending in Congress would both provide incentives for lenders to participate in this program. We will see. 


Some states give you the right to “redeem” your mortgage by refinancing up until the time of the foreclosure sale. A few even let you redeem for a certain period of time after the sale. You can find your state’s redemption rules, if any, on your state’s page in the appendix.


File for Chapter 13 Bankruptcy


In this kind of bankruptcy, you come up with a plan for making your regular monthly payments and paying off the arrears. If the bankruptcy court approves your plan, you’ll have three to five years to make the payments. Chapter 13 bankruptcy also reduces or eliminates your total debt load, making your mortgage more affordable in terms of your overall budget. In some situations (and depending on where you file the bankruptcy) you can get rid of a second or third mortgage entirely, reduce a first mortgage on a vacation or rental home to the market value of the house, and even reduce its interest rate on your first mortgage to 1.5 points above prime rate. Chapter 13 bankruptcy is discussed in Ch. 5. (In April 2009, a bill to allow Chapter 13 bankruptcy judges to reduce (cram down) mortgages on primary residences failed in the U.S. Senate after passing in the House.)


File for Chapter 7 Bankruptcy


If you are current on your mortgage (or can get current in a hurry) but have no room in your budget to continue making your payments, filing for Chapter 7 bankruptcy can make your mortgage more affordable by reducing your total debt load—and so help to prevent foreclosure in the long run. Chapter 7 bankruptcy is quick (about three months). It’s also inexpensive if you represent yourself, which many people do. Chapter 7 bankruptcy typically will wipe out your unsecured debt—for example, credit cards, personal loans, medical debts, and most money judgments. This will free up whatever income you were using to pay down those debts so you can put it toward your mortgage payments.


Even if you have decided to leave your house, bankruptcy can be of great assistance in keeping you in your home for a few extra months free of charge, and giving you a fresh start by wiping out liabilities arising from your mortgages or the fore­closure itself.


Despite these benefits, Chapter 7 bankruptcy may not be appropriate for you. For example, you may have more equity in your house than you can protect (exempt) in your bankruptcy, which means the bankruptcy would trigger an involuntary sale of your home. (Chapter 7 bankruptcy is discussed in Ch. 6.)


Chapter 7 or Chapter 13 Bankruptcy: A Quick Comparison
	Chapter 7	Chapter 13
Who qualifies	Anyone whose household income is below the state median OR who passes a “means test”	Anyone who has enough income to propose a reasonable repayment plan
Effect on foreclosure	Delayed two to three months	Delayed; possibly avoided
What happens to your property	You keep everything that is legally exempt; the rest is sold to repay your creditors	You keep your property, but you must pay your unsecured creditors the value of your nonexempt property
What happens to your mortgage	The amount you owe is discharged, but the lien created by the mortgage remains, and you must make payments to avoid foreclosure	Your first mortgage will probably remain intact; second and third mortgages can be eliminated if they are not at least partially secured by the house’s value
What happens to your debts	Most debts are wiped out (discharged); some (such as child support and back taxes) survive	You repay a per­centage of debt over three to five years, under a repayment plan you propose to the court; if you finish the plan, the rest of the debt is wiped out
How long it takes	Three to four months	Three to five years
Will you need a lawyer?	Probably not	Usually necessary

Take Out a Reverse Mortgage


A reverse mortgage is a way to tap into the equity of your home without selling the house. You get money from a lender and generally don’t need to pay it back as long as you live in the house. The loan must be repaid only if you sell your house or, after your death, when the house is sold and the lender is repaid from the proceeds.


You’ll be able to get a reverse mortgage (also called a home equity conversion mortgage) if you have substantial equity and are over age 62. These mortgages are heavily regulated by the Federal Trade Commission and can provide a safe approach to preventing foreclosure and preserving your equity for your own needs.


Reverse mortgages, because they take part or all of your equity, leave less value for you to pass on at your death. Also, it may be harder to obtain a reverse mortgage in a time of rapidly decreasing property values because the reverse mortgage lender, like everyone else, will be uncertain about the amount of equity you have in the property.


Finally, even though you don’t have to make payments on the reverse mortgage, you still may be responsible for paying the property taxes. This means that people on fixed incomes are at risk of losing their homes under a reverse mortgage that doesn’t provide for payment of the taxes by the reverse mortgage owner.


More information about reverse mortgages. Learn more at www.ftc.gov/bcp/edu/pubs/consumer/homes/rea13.shtm.


Fight the Foreclosure in Court


If you can show that the foreclosing party violated your state’s procedural rules for foreclosures or the terms of your mortgage agreement, you might be able to derail the foreclosure, at least temporarily. An increasing number of bankruptcy courts are requiring foreclosing parties to present documentary evidence of ownership and authority for bringing the foreclosure action before letting the foreclosure proceed. 


Because of the way mortgages have been sold and resold in recent years, documentary evidence of ownership is often either missing or not available when the court is reviewing the foreclosure. Violations of federal fair lending rules and other federal and state laws regarding consumer transactions may also provide protection against foreclosure. (Fighting foreclosures in court is discussed in Ch. 7.)


Extra protections for service members. If you are on active duty in the military, you can delay the foreclosure lawsuit—and get other help as well. See Ch. 4.


Give Up Your House


For some people, it makes economic sense to give up the house and move on. If so, there are several ways to say goodbye to it; you’ll want to choose the method that causes the least financial and emotional upset to you and your family. (There’s much more about making this decision in Ch. 3.)


Walk Away


If you have only a first mortgage, you may want to simply leave. But you’ll want to do this only if the lender cannot sue you if, after the foreclosure sale, the mortgage still hasn’t been paid off. (If the lender can’t sue you in this situation, you have what is called a non-recourse loan; check your state’s law in the appendix to see whether or not the lender can recover a deficiency (the difference between what you owe and what the lender ends up with). If no deficiency judgment is allowed, the lender will foreclose on the property to regain title, but you’ll be cut loose without owing anything to the lender. You might, however, be liable for income tax on the amount the lender comes up short (that amount may be considered income to you because you won’t have to pay it back).


If you have a second or third mortgage, walking away usually won’t get you off the hook for those debts—or, in many cases, for the tax on the amount the lender writes off. 


Arrange a “Short Sale” Without Foreclosure


You can arrange with your lender to sell the house, without foreclosure, for less than you owe on the loan. This is called a short sale. If you live in a state that allows the lender to sue you if the house doesn’t sell for a high enough price to pay off your mortgage, a short sale can be a good idea, but only if you get your lender to agree (in writing) to let you off the hook.


If you have a second or third mortgage, you’ll also have to get those lenders’ permission, which may be next to impossible given that they won’t get anything from the sale. Without permission from these additional mortgage holders, a sale of any kind won’t be possible in nearly all cases because these unpaid liens would remain on the title. 


Some people prefer short sales to foreclosure (and to bankruptcy) because of the conventional wisdom that a short sale will have a less negative impact on your credit score. (More about that in Ch. 4.)


Hand Over the House Without Foreclosure


You may be able to get your lender to let you deed the property over so that no foreclosure is necessary; this is called signing a “deed in lieu of foreclosure.” But before you go this route, you’ll want to have an agreement (in writing) that the lender won’t go after you for any deficiency that remains after the house is sold. And once again, this remedy probably won’t be available if there are second or third mortgages. As with short sales, some believe that a deed in lieu of foreclosure will be better for your credit than a foreclosure or bankruptcy.