Overview of Options Available for Distressed Borrowers
A "distressed borrower" is defined as someone who is unable to fully repay their mortgage due to financial difficulties. These difficulties are created by personal circumstance, or what the mortgage companies refer to as “financial hardships,” and are at risk of a foreclosure on their home.
Homeowners (Distressed Borrowers) are facing their worst nightmare – losing their home through the foreclosure process. Problems with the economy, job loss and/or mortgage industry crisis have left millions of borrowers in this situation. Not only are homeowners’ dealing with the monetary loss, but also emotional and mental distress over the loss of their home, neighborhood and community.
Choice…that is an important word for you to convey to a homeowner in financial distress because many individuals, couples and families in crisis do not realize that they are still the decision makers!
Timely decision making will give distressed borrowers the opportunity of choosing more than one option. Delayed decision making may force distressed borrowers into a corner with fewer available options. To decide not to decide may result in a foreclosure being the only option left because too much time has passed to consider alternative options. The following is a list of options available for distressed borrowers facing tough decisions.
There are three categories or options for Your Distressed Borrower to Consider before Making a Decision:
- Keeping their home, and debt and modifying their mortgage payments.
- Pursuing a foreclosure alternative.
- Foreclosure because a decision was not made.
Keeping Your Home
Keeping your home also means keeping your current debt. Keeping your home can be an option for borrowers who qualify for a home retention program. In other words, you can keep your home if your lender determines that you can afford to keep your home on terms acceptable to your Mortgage Company or servicer.
Loan Modification is where your lender permanently changes the original terms of your mortgage so that you can permanently afford the monthly mortgage payments. This is typically achieved by:
- Reducing the interest rate on your loan
- Extending the term on your loan (for example, from thirty to forty years),
- Delaying payments on a portion of your loan (typically called principal forbearance)
In some cases, forgiving a portion of your loan (called principal forgiveness).
If your financial problems can be resolved within six months then there are two broad alternatives to consider and you can afford your loan payments:
2. Forbearance/Repayment Plan: A key to remember here is that that will not be a permanent change to the terms of your mortgage loan. This plan is offered to help borrowers facing short-term financial difficulties (less than 6 months) to keep their home.
- A forbearance plan puts your monthly payments on hold or reduces the payment for a specified time period.
- A repayment plan spreads the past due amount over several month to catch up.
Here is a specific example to help you better understand how a forbearance and repayment plan might work:
The lender offers a short-term forbearance solution to be implemented allowing a homeowner to make half their usual loan payment for six months and offers a repayment plan allowing the homeowner to make up the short payments from the first six months in the following twelve months. The first six months of lower payments is forbearance and the following twelve months of higher payments is a repayment plan.
Foreclosure Alternatives
If you can’t afford your monthly payments and have a long-term financial hardship and are willing to voluntarily leave your home, you should consider two foreclosure alternatives:
- A Short Sale or a Homes Affordable Foreclosure Alternative ‘HAFA’ Short Sale is a pre-foreclosure alternative in which you sell your home for less than the balance due to the mortgage company and move out of the home.
- A Deed-in-Lieu or Homes Affordable Foreclosure Alternative ‘HAFA’ Deed-in-Lieu of foreclosure is when you voluntarily transfer ownership for your property back to the mortgage company in exchange for no further monthly payments on the loan. You will need to move out of the home.
Short Sale Option
The main foreclosure alternative available to most distressed borrowers is ‘short selling’ your home. A short sale is defined as the sale of your home to an interested buyer for less than the balance due to the mortgage company. Once the sale is complete, you must move out of the home.
In many but not all cases, the loan holders forgive the “short” amount of the debt – the difference between what you owed and what you paid back. This is a very important aspect to understand about short sales. If you decide to pursue a short sale, you are advised to understand the debt forgiveness terms offered to you and to consult your tax professional for consequences, if any, related to your specific situation.
You should also note that debt forgiveness for the difference between your debt and the actual proceeds from selling your home is mandatory under the government’s Home Affordable Foreclosure Alternatives or HAFA program, which we shall discus shortly.
A specific example to help you better understand what I am talking about here. If you owe $500,000 on your loan but your home is only worth $400,000 then you can typically only sell your home through a short sale and receive debt forgiveness if you have one of the qualifying hardships or if debt forgiveness is mandated by law. The difference between what you owe and what your sell your home for – let’s call it $100,000 in this example to keep it simple – is the ‘short amount’ of debt that would be forgiven.
The basic difference between a short sale and foreclosure is that in a short sale you make the decision on when and how to ‘give back your home’ whereas in foreclosure your lender pursues the legal process to evict you and take back ownership of the home. A key point for you to know here is that the lender does not typically want to take your home back and will do so as a last resort.
Another key difference is how mortgage lenders including the government sponsored entities Fannie Mae and Freddie Mac view former homeowners who “gave back their home” … and want to borrow again in the future to buy another home.
Homes Affordable Foreclosure Alternative "HAFA" Short Sale Option
The governments foreclosure alternative program is called Home Affordable Foreclosure Alternatives program or HAFA. For many distressed borrowers this seems like the right course of action because of the many benefits it offers.
The HAFA program is the best foreclosure alternative program available to distressed borrowers and more than 105 lenders are signed up to participate in the program. HAFA is unique because it includes:
- Mandated debt forgiveness by all loan investors with liens on the property.
- This allows qualifying families to walk away debt free.
- $3000 in relocation support to help the family move.
- Standard terms and conditions and approval timeframes.
With so many benefits available to the distressed borrowers and mandatory guidelines for Mortgage Companies to adhere to, a HAFA short sale may be your best solution.
It is important to note: HAFA is a “full documentation” program so you may be asked to provide detailed financial documentation to your lender before they can determine you if you qualify.
Deed-in-Lieu Option
A Deed-in-Lieu or ‘HAFA’ Deed-in-Lieu of foreclosure is when you voluntarily transfer ownership for your property back to the mortgage company in exchange for no further monthly payments on the loan. You will need to move out of the home.
If you can no longer afford your home and all of the other alternatives to stay in the home have not worked out for you and a foreclosure is now an unavoidable option, you may want to consider a Deed-In-Lieu, which would help you resolve your delinquency and avoid foreclosure.
What are the benefits of a Deed-in-Lieu?
- Potential to eliminate your remaining mortgage debt.
- Avoid the negative impact of a foreclosure.
- May be eligible for relocation assistance in some cases.
- Start repairing your “credit score” sooner than if you choose foreclosure.
For a Fannie Mae mortgage, you can purchase another home sooner (in as little as 2 years) than if you went through foreclosure (3 - 7 years)
Foreclosure Option
A foreclosure occurs when the distressed borrower stops making monthly payments as agreed. The mortgage company will attempt to get the borrower to apply for a loan modification or another pre-foreclosure alternative and typically does not want to take the home back into their inventory.
If the distressed borrower makes no attempt to work with the mortgage company, they are forced to begin the legal procedure to take back the house.
What are the consequences of a Foreclosure?
- You will be evicted from your home.
- You will have increased stress because you will not know exactly when you will be forced to leave your home.
- You will damage to your credit which will impact your ability to get new housing, or credit for 5 – 7 years.
Strategic Foreclosure
A strategic foreclosure occurs when a homeowner who has the ability to pay their mortgage, but intentionally decides to stop making their mortgage payments while still living in the home.
Per Fannie-Mae, defaulting borrowers who walk-away and had the capacity to pay or did not complete a “workout alternative” in good faith on Fannie Mae backed loans will be ineligible for a new Fannie Mae-backed mortgage loan for a period of seven years from the date of foreclosure.
What are the consequences of a Strategic Foreclosure?
For Fannie Mae back loans, you will forfeit your ability to get a Fannie Mae mortgage to purchase another home for at least 7 years according to the Fannie Mae guidelines. Further information:
http://www.fanniemae.com/newsreleases/2010/5071.jhtml
***The information provided is general information and is considered helpful for agents and their distressed borrowers experiencing trouble keeping up with their mortgage payment due to financial hardship. This information has not been prepared by a lawyer, tax accountant, or financial advisor. Nothing should be viewed as financial, legal, or tax advice. Please consult appropriate professional for personal advice.***