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What to Know About Mortgage Default

When the unexpected happens and it’s a struggle to keep up with mortgage payments, you could quickly find yourself in mortgage default. That’s when you don’t meet the terms of a mortgage and fail to make payments.

A mortgage default could lead to serious consequences — foreclosure being the worst-case scenario. If you find yourself in financial turmoil, take heart, because borrowers in default have options. Let’s take a closer look.

What does a mortgage default mean?

Mortgage default means that you’re not complying with the terms of your mortgage. If you pay your mortgage late, or if you pay less than your required monthly payment, you’re considered delinquent. Generally, after being delinquent on payments for 90 days, your loan goes into default.

The defaulted definition also includes not meeting other requirements of your mortgage. For example, you can be in default for not paying your property taxes or your mortgage insurance premiums. Mortgage default can lead to foreclosure, which is when a lender takes back your home.

Situations that can lead to a loan default

We know the loan default definition, but what leads to default? Default typically arises after a financial hardship, such as:

  • Divorce
  • Job loss
  • Medical bills
  • Death or illness of a primary income earner
  • Reduction in income
  • Financial emergencies like an unexpected home or car repair
  • Increasing credit card or other loan debt
  • An increase in your mortgage rate

Some mortgages, called adjustable-rate mortgages (ARMs), have rates that can change after an initial fixed period. For example, a 5/1 ARM has a fixed rate for the first five years of the loan. After that, the rate can change once per year.

What is a ‘walkaway?’

Mortgage defaults can also happen for another reason. Borrowers may consider walking away from a mortgage, which is also known as a strategic foreclosure or strategic default. During the housing crisis of 2007 to 2008, many homeowners saw the value of their homes drop. As a result, homeowners owed more on their mortgages than their home was worth. Some homeowners decided it made more sense to walk away from their homes and mortgage obligation than to try and salvage their mortgage.

Mortgage default rates during that time reflect this trend. The number of mortgages in default peaked at 4.2% in January of 2009. A decade later, the number of mortgages in default was 1.7% in June 2019, according to data from the Consumer Financial Protection Bureau (CFPB) and the National Mortgage Database.

6 ways to avoid foreclosure after a mortgage default

If you’ve missed a mortgage payment, or if you think you might miss one, don’t wait until you get a default notice to act. The first step is to call your lender. Your lender may have options to reverse default. You should also consider calling a HUD-approved housing counselor for help.

Here are six ways to avoid foreclosure:

  1. Refinance. If you qualify and your lender allows it, refinancing your mortgage may be a viable option. With a refinance, you get a new mortgage with terms that are a better fit for your financial situation. The new mortgage pays off the old mortgage. You can even refinance if you are underwater with special programs through Fannie Mae and Freddie Mac.
  2. Loan modification. A loan modification is a change to the original terms of your mortgage. Your lender might agree to reduce your payment amount or interest rate to make your loan more affordable if you’re facing a documentable hardship.
  3. Forbearance. A forbearance is when your lender agrees to suspend or reduce your payments temporarily. This could include late mortgage payment forgiveness, but it’s best to contact your servicer promptly to discuss your options.
  4. Loan forgiveness. As part of a loan modification, your lender may agree to forgive part of your debt so you have lower payments. Any forgiven debt may have tax consequences, so keep that in mind as you discuss your options. Although there isn’t a VA home loan foreclosure forgiveness program, the VA does provide financial counseling at its regional loan centers.
  5. Deed-in-lieu of foreclosure. A deed-in-lieu of foreclosure allows you to voluntarily transfer your property to your lender, and your lender discharges your mortgage. You typically have to complete a deed-in-lieu of foreclosure form explaining your hardship to qualify.
  6. Short sale. With a short sale, you work with your lender to sell your home for less than the full amount you owe. You may have to pay taxes on the forgiven mortgage balance, though.

Keep in mind that if something sounds too good to be true, it probably is. Scammers sometimes prey on people facing foreclosure. Be wary of any program that asks for upfront payment or offers a forensic audit, which are red flags of a potential foreclosure scam.

What are the consequences of foreclosure?

A mortgage default ultimately results in foreclosure, or loss of your home to the lender. The consequences of a foreclosure can follow you for years. Here’s an overview.

  • Your credit will take a hit. Credit scores can drop by 150 points or more after a foreclosure, according to a recent LendingTree study. How long does a foreclosure stay on your credit report? It typically takes seven years to fall off.
  • You’ll lose your home. The most important foreclosure and loan default consequences are personal. The financial and emotional stress of losing a home has a lasting impact on a family’s well-being. It can impact physical and mental health. It’s also much harder to qualify for another mortgage or rent a home with a foreclosure on your credit, which can be more stressful.
  • You may have to file for bankruptcy. Some homeowners delay or stop the foreclosure process by filing for bankruptcy. Chapter 13 bankruptcies stay on your credit report for seven years, while Chapter 7 bankruptcies stay on your credit report for 10 years.
  • Your lender might sue you. When a lender forecloses on your home, it sells it to pay off your mortgage balance. If it doesn’t sell for enough to cover what you owe, your lender could sue you for the balance.
  • You’ll have to wait several years to buy another home. It can take two to seven years to qualify for another mortgage after a foreclosure. Foreclosures show up on CAIVRS, a government database that lenders check. The waiting period varies depending on the type of mortgage:
    • Conventional loan: You’ll have to wait seven years, but it can be as little as three if there were extenuating circumstances such as sudden unemployment.
    • FHA loan and USDA loan: Mortgages backed by the Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) both require a wait time of at least three years.
    • VA loan: Loans guaranteed by the U.S. Department of Veterans Affairs (VA) for military borrowers require a two-year wait.

What is an underwater house?

An underwater house has a mortgage balance that’s higher than the home’s value. For example, let’s say you bought a home 10 years ago for $500,000 with a mortgage of $425,000 after putting down a $75,000 down payment. Fast-forward to today: Home values in your area suddenly dropped, and now your home is worth $300,000, but your mortgage has a balance of $350,000. Your loan is underwater by $50,000.

Underwater homes aren’t in default, but many homeowners walked away from underwater homes rather than continuing to pay their mortgage when home values plummeted during the housing crisis. As of the third quarter of 2019, 6.5% of all properties with a mortgage are seriously underwater, according to ATTOM Data Solutions. This means that the mortgage is at least 25% more than the home’s value.

 

 

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