Introduction

Foreclosure doesn’t usually come as a big surprise to homeowners. You probably know, well before it happens, that you’re going to have trouble making your mortgage payments. Maybe you’ve been laid off or face unexpected medical bills, or maybe that adjustable-rate mortgage you took out a couple of years ago is scheduled to reset at a much higher rate, making payments out of reach.

Once you do fall behind, you’ve probably got a few months before your lender even starts the foreclosure process. The fact that foreclosure is a process—sometimes a long one—is good news for you. You don’t need to panic. You’ll have time to plan, negotiate, and evaluate your options—IF you act as soon as you smell trouble coming. The more time you have, the better.

If your only problem is a few missed payments, your lender will probably be willing to let you get current over time or even add the missed payments to the end of the loan. If you’ve missed four or five payments, your lender may not be flexible— but you still may be able to work something out.

Don’t wait for the lender to contact you. Just as soon as you realize you’re going to have trouble making your mortgage payments, you can and should start working on the problem. This chapter will show you how.

CAUTION: Don’t panic—and don’t get scammed. Foreclosure rescue scams have popped up all over the country in response to the soaring foreclosure rate. Almost without exception you will be worse off with these scams than if you let the foreclosure go through. To find out how scammers work and what to look for, see “Don’t Get Scammed by a Foreclosure “Rescue” Company,” below.

What to Expect

When you’ve missed some payments, the lender gets things started. With so many homeowners behind on their mortgages, you may not hear from the lender for three to six months after you miss the first payment.

Depending on the procedure required by your state, you’ll receive some sort of formal written notice that foreclosure is in your future unless you make things right. Foreclosure procedures differ greatly depending on where you live and the nature of the loan. (Ch. 2 explains these procedures and highlights the variables you’ll want to know about when planning your strategy.)

Unless you use one of the remedies explained briefly below (and in detail in later chapters), the foreclosure will end, after a few months, with the sale of the property, typically at a public auction. The foreclosure process is explained in detail in Ch. 2.

Your Options: An Overview

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

If you want to keep your house, your best approach is to start negotiating with your mortgage servicer as quickly as you can. 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.

You can negotiate directly or through a nonprofit housing counseling agency. It’s always worth calling one of the nonprofit agencies—the counselors there will help you, for free, explore possible remedies and negotiate a workout with your lender. (Ch. 4 explains how to find a nonprofit housing counseling agency and how it can help you.)

You may have even more workout options available to you if your loan is owned, insured, or guaranteed by a government agency or a government-chartered company such as Freddie Mac, Fannie Mae, Federal Housing Administration, HUD, VA, or the Rural Housing Service.

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. On the other hand, the Housing and Economic Recovery Act of 2008 provides massive funding for the purpose of converting eligible variable-rate mortgages into 30-year fixed loans insured by the Federal Housing Administration. See below.

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 you can get rid of a second or third mortgage entirely, reduce your first mortgage to the market value of the house, and even reduce the interest rate on your first mortgage to just a little above prime rate. Chapter 13 bankruptcy is discussed in Ch. 5.

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, going through Chapter 7 bankruptcy can make your mortgage more affordable—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 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 property than you can keep in a bankruptcy, which 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] omitted for online sample chapter

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 are 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.

Resource: 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 courts are requiring foreclosing parties to present documentary evidence of ownership and authority for bringing the foreclosure action. Because of the way mortgages have been sold and resold in recent years, this evidence 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.)

Tip: 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 could come after you if a foreclosure sale doesn’t yield enough to repay the mortgage.) 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 won’t get you off the hook for those debts—or for 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 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.

How You Can Stay in Your House Payment Free

The basic concept of foreclosure is that when a house is sold at an auction, the lender will recover the amount of the mortgage, and the new owner will move in and live happily ever after. Or maybe an investor will buy the home, rent it out for a while (maybe to you), benefit from some tax write-offs, and then sell it when it has gone up in value.

The thing is, that’s not how it works these days. Unfortunately for the banks and investment communities, neither of these scenarios reflects reality for one simple reason: Prospective buyers are unwilling to offer the minimum bid—typically the amount necessary to pay off the first mortgage. And so the lender is stuck with property it doesn’t want. Lenders aren’t landlords; few have divisions that can rent the property out, manage it, and resell it when the time is right.

Primarily for this reason, lenders are putting off foreclosure proceedings as long as possible, in the hopes of working something out with the homeowners to keep them in their houses—and keep at least some mortgage payments flowing in. If, early on, you decide that you don’t want to keep the house and will ultimately be moving on, you may be able to skip payments for many months before foreclosure is finally begun. And even after the foreclosure sale, chances are great that you can keep living in the house for a while longer free of charge. In all but a few states, you can stay in your house until the new owner gives you a formal written notice demanding that you leave. (See your state’s page in the appendix.)

Having payment-free shelter for many months—both before the foreclosure action is brought and after the sale—gives you a golden opportunity to save some money. And that will grease the skids when you do have to find a new place to live. (See Ch. 9 for more on how to come out of foreclosure with some cash in your pocket.)

Why Foreclosure Doesn't Have to Be So Bad

Okay, I may have already lost you on this one. But stay with me for a moment, because I’m convinced that home ownership can be overrated.

Americans take for granted that owning a home is superior to renting one, especially if you have a family. We accept the phrase “American dream” without question when applied to home ownership. And politicians are wringing their hands over the prospect of the American dream being lost for the millions of homeowners who face foreclosure.

From my own experience, having owned and rented in several different parts of the country, and having worked with clients throughout my career, I know that ownership is not an automatic key to happiness. (I go into this in more detail in Ch. 3.) For now, just try to open your mind to the possibility that renting rather than owning is not always a bad way to go.

Don't Get Scammed by a Foreclosure "Rescue" Company

A large “foreclosure rescue” industry, much of which is a scam— has mushroomed right along with the number of foreclosures. If you are close to losing your home to foreclosure, you may receive an offer of help from a foreclosure rescue company. Companies scour public records and call homeowners who’ve received foreclosure notices.

The con artists who run these companies will tell you that they have resources that are unavailable to the nonprofit housing counseling agencies, and that they care about you and will find a way for you to save your “American dream.” But unlike the nonprofit housing counseling agencies, these companies aren’t really trying keep you in your house. They’re trying to make money. If you have equity in your house, they go after it. And if you’ve got only cash, they’ll go after that.

Scams That Target Home Equity

If you have significant equity in your home, you are a prime target for the mortgage rescue scams aimed at getting ownership of your house away from you.

One common trick sounds especially good because the mortgage gets quickly reinstated, at least temporarily.

What you’ll hear: “We’ll buy your house right now—just temporarily, of course. We’ll make the mortgage payments. You can stay right where you are, lease the house from us, and buy the house back when the loan is paid off.”

What really happens: The foreclosure rescue company is confident that you won’t be able to buy the house back, especially if it involves a big balloon payment, which is common. Ultimately, you lose your home and are quickly evicted. Eviction comes quickly because you have only the status of a tenant under the lease or rental agreement that was supposed to be temporary. By contrast, if the house had gone through foreclosure, you would have had been able to stay there for months payment free as the foreclosure process went on.

Another scam involves wresting ownership away from the homeowner without the homeowner’s knowledge.

What you’ll hear: “We’ll get a workout with the lender. We’ll handle everything—just send your mortgage payments to us and we’ll pass them on to the lender.”

What really happens: The papers you sign actually transfer ownership to the company. (This can easily be accomplished because people expect legal documents to be full of gibberish they don’t understand, or don’t notice that the documents they sign have blank lines that can be filled in later with terms they never agreed to.) Instead of sending your mortgage payments to the lender, the scammer uses them to refinance the property. Then it sells the house to an innocent third party and disappears, leaving you without equity or a workout.

If You Don’t Have Much Equity

If you have little or no equity in your home, you probably won’t be approached by anyone who wants title; what would be the point? But if you are close to a foreclosure sale, there are plenty of other snake-oil peddlers out there.

For a stiff up-front fee—often in the thousands of dollars— they offer to help you fight your foreclosure by finding affordable loans or by negotiating with your lender for a mortgage modification, an interest rate freeze, or an arrangement in which your missed payments get added to the end of your loan. In short, they charge you to do what the nonprofit counseling agencies do for free. But not only will you not get results, there’s a good chance that the rescue company will disappear once it has your money in hand.

Example: Frieda and Ted are in foreclosure. They are trying to negotiate a workout with their servicer but are continually told to be patient and that their proposal is moving through the process. Their home is due to be sold in three weeks and they are beginning to panic. They wake up one morning to find a flyer on their doorstep advertising the Compassionate Care Foreclosure Rescue Service, which seems tailor-made for their difficulties. The flyer asks, “Is your home about to be sold at a foreclosure sale? Are you having trouble negotiating with your mortgage servicing company? Want to refinance your mortgage at a low interest rate? We can help!”

They call the number on the flyer and are referred to a “foreclosure rescue specialist,” Nick, who tells them in a soothing voice that Compassionate Care has helped “thousands of people just like you” work out their mortgage difficulties and stay in their homes. After Frieda and Ted give him information about their plight, Nick tells them that he can negotiate with the servicer on their behalf and get an extension of the foreclosure sale date so they’ll have more time to work something out. The fee: $1,500, up front.

Frieda and Ted borrow the $1,500 from Frieda’s son and send a cashier’s check to Nick at a post office box, along with a signed power of attorney form that Nick says he needs so he can negotiate with the servicer. A few days later Nick tells them that he has gotten the foreclosure sale postponed. Two weeks later, after the date the home was to sold at the foreclosure auction, Frieda and Ted get a call from someone they’ve never heard of telling them that he bought their home at the foreclosure sale and wants to make arrangements for them to move out. Frieda and Ted call Nick in a panic. The number has been disconnected. Frieda and Ted have lost their home—and paid $1,500 for the privilege.

Remember that if something seems too good to be true, it probably is. Or, as my father taught me: You don’t get something for nothing. I confess that I started to doubt this over the past five or 10 years. A good credit score could produce hundreds of thousands of dollars just for the asking, and it was easy to forget about the debt because of soaring property values and the marvelous tool known as refinancing. Now that the balloon has popped, it’s time to dust off these old truisms.