Foreclosure is THE #1 WORST THING that can happen to your credit report—even worse than bankruptcy. Besides losing your home, your equity, and any shred of credit you had left, this means:

  • NO new loans of any kind for a minimum of 3-7 years.
  • NO renting/leasing where credit reports are pulled.

The average foreclosure costs lenders $58,792 and requires 18 months to resolve. Besides the cost, there are BIG financial and economic reasons why:

- HUD wants to homeowners to keep their homes.
- Fannie Mae, Freddy Mac & Friends want to find ways to cut mortgage losses.
ESPECIALLY during periods of job loss in economic recession.

Today, mortgage workout options are widely used throughout the industry. Lenders are encouraged to find foreclosure alternatives whenever possible. The following is a list that would be very valuable to any homeowner who has just received a Notice of Default (NOD).

But first you have to understand the lender’s perspective:

Most lenders require an involuntary inability to pay before workouts are approved, meaning the borrower does not have the capacity to fully reinstate and carry the mortgage due to illness, job loss, significant property damage or depreciation, or other significant economic shock.

Obviously, if the homeowner has money and they are voluntarily borrowing their mortgage payment to keep current on a new Ferrari then there is no reason for a workout. That is why most lenders pull credit and require homeowner W-2 forms, 2 months bank statements, 2 most recent pay stubs, 401(k)s, etc. prior to approving a workout option.

Regardless of lender policy, the borrower can simply fully reinstate or cure the mortgage
by paying all the past due amounts and fees owed, and thus retain ownership interest in the property. The borrower can do this at any time prior to the finalization of the foreclosure and even after foreclosure sale in states that allow redemption

From the lenders perspective, a “cured” loan is any loan that either fully reinstates, gets
modified, is assumed by a new borrower or is paid off. While a “failed” loan is any loan that results in the loss of the home through foreclosure or foreclosure alternative such as a deed-in-lieu, short sale, or workout assumption.

Lenders WANT to work with homeowners because they want their loans paid. But curing delinquency is a lot like cancer: The earlier you catch it, the more options you have. Lenders know more than 61% of loans that get to 120-days delinquent will fail—at that point lenders recognize they’re obviously going to lose money and the question becomes, “How much?”

So turning to that question, there are many different alternatives to foreclosure once a borrower is in default. In fact, many of these alternatives are relatively recent innovations in loan servicing (eg. from the 1990’s). Not every lender has every workout option available—most of them do but they call them by different names.

So the following list is divided into two groups: The first group involves workouts that allow the borrower to reinstate the mortgage over time and keep the home. The second group involves workouts result in voluntary title transfers if a borrower has demonstrated involuntary inability to pay.

Home Retention Workout Options

Partial reinstatement is when the borrower resumes regular monthly payments and agrees to a repayment plan over a period of up to 12 months for the remainder due. In this case, the borrower’s credit record will indicate that the borrower is meeting his or her obligation and that a repayment plan is in place. Nevertheless, the number of months for which the borrower was delinquent and the severity of the delinquency will continue to appear on the borrower’s credit report. If the borrower partially reinstates the mortgage but does not enter into a repayment plan, then his or her credit record will indicate a continuation of the delinquency for the number of months due in arrears, e.g., the borrower would remain two or three months at “60-days delinquent” status, also known as 2×60 or 3×60 days delinquent.

Short-term forbearance allows for the suspension of up to three payments or a reduction
in payments for up to 6 months with a repayment plan to follow at the end of the forbearance period.

Long-term forbearance allows for the suspension or reduction of payments for a period of 4 to 12 months with a corresponding repayment plan for full reinstatement or payoff within 12 months of the end of the forbearance. If the borrower seeks forbearance prior to delinquency, his or her credit report will only indicate the presence of a repayment plan; otherwise, such as with the case of partial reinstatement, if the borrower pays as agreed under the repayment plan, he or she limits the damage to his or her credit history from the delinquency.

Loan modification is a permanent change in one or more terms of a borrower’s loan that allows the loan to be reinstated and results in a payment the borrower can afford. A loan modification is negotiated when a cooperative borrower has indicated a desire to retain ownership of the property and a capacity to support a mortgage under the new terms and does not qualify for a refinance of the loan under lender/investor policies. Under a loan modification, a borrower’s credit record is restored to “currently paying as agreed” status.

Partial claim or Advance Claim is offered under the FHA loan loss mitigation program, and is a workout in which the lender will advance funds on behalf of the borrower in an amount necessary to fully reinstate a delinquent loan (not to exceed 12 months of principal, interest, taxes and insurance (PITI)). The borrower, on acceptance of the advance, will execute a promissory note and subordinate mortgage payable to HUD. Currently, these promissory or partial claim notes carry no interest and are not due and payable until the borrower either pays off the first mortgage or no longer owns the property.

Refinancing is good option as long as you have acceptable credit, can afford closing costs on the loan, and have no liens or judgments clouding title. A good mortgage broker knows how to get you financed as high as 106% LTV. Obviously you want to make sure you can afford the new payment and you won’t default again or it’s back to square one.

Filing Bankruptcy may be an option for those who haven’t done it before. You can only do it once per chapter and there are multiple chapters of bankruptcy, but the two that apply to residential homeowners are Chapter 7: Asset Liquidation and Chapter 13: Payment Reorganization. Although it is possible to keep your home in both chapters, it is not a guarantee. If there is enough equity, the judge may order the home to be sold to help pay off creditors—even if the home is somehow sold for a profit after all creditors are paid you would only get the maximum homeowner’s exemption allowed in your state (eg. $20k in Utah) while the rest goes straight into the Bankruptcy Trustee’s pocket. In any case, a good bankruptcy attorney knows how to delay foreclosure proceedings for a year or two while the homeowner lives rent free. The only downside is if you lose, you now have a bankruptcy and a foreclosure on your credit report. Ouch!

Voluntary Title Transfer Workout Options

Selling traditionally is probably the best option provided there is enough time before the foreclosure auction and the homeowner doesn’t owe more than the house is worth. Sometimes if there is a lot of equity the lender will even lower or stop payments for a while to give you time to sell (see above: reinstatement)

Deed-in-lieu of foreclosure is the simplest case, and involves the borrower foregoing any continued ownership interest in the house in exchange of the cancellation of the mortgage obligation – essentially the borrower just hands over the keys.

Short sale or short payoff or preforeclosure sale or sale and compromise is a negotiated and lender approved sale where the borrower has found a buyer for the property (such as an investor), but the sale proceeds are less than the amount owed inclusive of sale costs and other fees. In this case, the lender either negotiates an unsecured repayment plan with the borrower for the additional amount owed or forgives the remaining debt.

Workout mortgage assumption permits a qualified applicant to assume title to the
property and the mortgage obligation from a borrower who is currently delinquent or is in
imminent danger of default because of involuntary inability to pay. This is valuable if the mortgage carries a below-market interest rate that would make its sale more attractive, and in cases in which the assumption permits the purchaser to obtain a higher loan-to-value ratio than could otherwise be attained. Lenders will waive the due-on-sale clause of fixed-rate mortgage contracts as needed to assist troubled borrowers sell their properties and avoid foreclosure.

Conclusion
In many cases borrowers are better off getting out of their existing homes. There may be a need to find employment elsewhere, a divorce settlement that requires selling the property, reductions in income that necessitate moving to lower cost housing, or a deceased borrower with an estate to be liquidated.

Since these are serious problems that most real estate professionals are not trained to handle, it’s a good thing there are Investors out there to help these people.