Everyone instinctively knows when the time is right, but not everyone knows what to do or how to do it—and too many let the right time go by without taking action. The time to take action is when you receive the first notice that your 6% Adjustable Rate Mortgage (ARM) is now an 11% ARM, or when you wake up in the hospital and discover that you no longer have the ability to earn an income adequate to meet your debts, including your mortgage. For others, the death of an under-insured income earner, or suddenly discovering that your medical expenses are about to erase your savings and ability to meet your debts. What ever the tragic circumstance, you know at that point that you are facing trouble, and you can hear the freight train bearing down on you.
Take Early Action
Now is the time to contact your mortgage lender—before you default on your payments. If you think it is too embarrassing to admit financial trouble, imagine how much more embarrassing it will be when you go into foreclosure. If you are concerned that your lender will begin foreclosure consequent to your contact, get that out of your mind! Unless or until you go into default, they are powerless to take action. What's more, they will stand on their head to help you avoid losing your home if it is at all possible for several reasons.Not only is foreclosure a costly process for lenders, but carrying foreclosed property on their books requires that they keep five times the loan value of forelosed properties in reserve—it prevents them from doing the very business from which they profit! Recent legislation and incentives offered by the department of Housing and Urban Development (HUD), secondary mortgage market participants like the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) are helping lenders avoid foreclosure and bear up to what would otherwise have left it as their only alternative. The Federal Reserve System (Fed) has also kicked in several times by lowering rates for lenders, and most recently offered short term loans against Treasury Bills, and allowed that lenders can use their inventory of foreclosures as collateral!
HUD outlines a number of loss mitigation options available to home owners, and actions to take before the crisis becomes unmanageable, including information about the availability of a HUD housing counselor. Military personnel and their spouses, including eligible reservists and guardsmen, can also take advantage of the Servicemembers Civil Relief Act of 2003.
The next step toward saving your home and credit rating is to contact lenders who are carrying unsecured debt,—credit card accounts, personal lines of credit etc.,—and work out a plan to reduce your monthly debt service. If at all possible, stop using these beyond your ability to pay off any additional debt as well. If medical expenses are part of the hardship, make arrangements to pay against the debt over time. As a last resort, payment on these debts can be temporarily suspended without significant long-term damage to your credit rating. Yes, doing this will affect a borrower's credit rating, but those with otherwise good to excellent credit ratings will be able to establish new credit with little or no repercussions when the crisis has passed and the need arises.
If taking early action has gotten a home owners out of harm's way, great! If not, or if the home owners waited too long (has received two late payment notices from the mortgage lender), there may still be time and options available. Note, once the home owners receive the foreclosure notice, it is likely too late. At this point an agreement with the lender to accept a deed-in-lieu of foreclosure may be the only option. It saves the lender the time and expense of going through the foreclosure process, and relieves the home owner from the debt. It will likely not save their credit rating though. Even so, it is far less damaging to a credit rating than a foreclosure.
Additionally, lenders would like to assure that the defaulting borrowers do not damage the property prior to vacating it, and offer a "Cash for Keys" stipend of $1,000 (VA) to $2,000 to induce those who fail to vacate the property after the first notice to quit. This is available as part of the deed-in-lieu of foreclosure agreement, but must be applied against any outstanding second mortgages or other liens on the property if such additional encumbrances exists.
What Then?
Even after a home owners defaults on one or two payments or learns, after all they have done, that their debt is not manageable—and the freight train's headlight is on them—they can still get off the tracks before they are hit. They have less time and fewer options at this point, but all is not yet lost. They may still be able to work out one of the loss mitigation options mentioned above, or, if needed, take advantage of a Pre-foreclosure Sale if they have the equity to cover the mortgage debt and settlement costs, or a Short-Sale if they do not. Note that HUD uses the term Pre-foreclosure Sale as a synonym for Short-Sale.Short-sales refer to the sale of a property that will net less that the amount owed on the mortgage. In such sales, banks will not only accept less than they are owed, but will absorb the settlement costs. While the sellers will walk away from the closing of the sale with nothing, they will be free of the mortgage debt and will have had to pay nothing out-of-pocket to close the sale.
Short-sales have been available for a long time, but the public is becoming increasingly aware of them subsequent to the sub-prime lending fisco that led to the mortgage market melt-down. In the past, this option provided only a way to get out of an unmanageable mortgage debt, while incurring srious damage to their credit rating. Now, lenders are not only willing and able to forgive part of the mortgage debt, but willing not to report the deficiency to the credit reporting agencies! This is not a certainty though, and the sooner home owners act, the more likely they will salvage their credit rating. A little pleading and persuasion will likely be necessary to convince the lender not to report the deficiency, and it will be best to get some written guarantee to that effect.
If the lender will not agree not to report the deficiency to the credit reporting agencies, worse things could happen. The home owners could decide to allow the property to go into foreclosure, and thereby thoroughly ruin their credit rating.
As a side-line, it is worth noting here that the Mortgage Forgiveness Debt Relief Act of 2007 now also excludes the foregiven debt from taxation. In the past, it had been counted as regular income!
The requirements to take advantage of a short-sale have already been covered, but recapping them at this point may help clarify just what they are:
- A legitimate hardship preventing the home owners from meeting their debt structure.
- Falling behind on payments.
- Too little value (equity) to sell without a loss.
The ABCs of Short-Sales
Regardless of the type of loan, the first step in the short-sale process is to list the home for sale through an agent for a real estate brokerage that is a REALTOR® member of the local Multiple Listing Service (MLS). Lenders know the business, and know that a professional is not only more likely to sell the property within the allotted time, but to sell at the best price the market will bear. Selling by owner (FSBO) is not an option. Typically, the listing period a lender will allow will be between 60 and 120 days.An agent who is associated with one of the larger, more successful firms in the area will likely have access to help from short-sale experts who are either trained or experienced enough to assist the agent and seller. It's not a terribly complex process, so direct experience with it should not be a major concern. There are plenty of agents with experience who have not done it entirely right yet.
If the sellers have already been in touch with their lender, they will likely have already filled out a form providing the necessary financial information for their lender. If not, the agent should have a form available for this purpose, or the seller will need to meet with the lender to provide this information. Though many of these forms authorize the release of information to the agent, it is best to obtain a separate authorization to release information which names the agent, brokerage and title company officers who will be handling the transaction.
To recap this section, with the exception of Federal Housing Administration (FHA) loans, these three things constitute the short-sale package that the pearties in the transaction will need: 1) A listing agreement with an MLS member REALTOR®; 2) The borrower's financial statement; and 3) An authorization for the lender to release financial information.
FHA Short-Sales
In addition to the points made in "The ABCs of Short-Sales" above, FHA short-sales require that the short-sales package include an FHA approved appraisal that demonstrates that the proposed sales price meets certain ratios, and that the seller first meet with an HUD approved housing counselor. The appraisal will provide an "as is appraised value" that must be at least 63% of the total of the outstanding principal on the mortgage note, plus, delinquent interest, plus any partial claim payoff amount, if applicable. It must also be at least 82% of the contract sales price minus allowable PFS expenses and partial claim junior lien amount if applicable.HUD short-sale listing agreements are limited to 90 days. In addition to those items mentioned in the standard short-sale package, HUD will require: 4) An as is appraisal by an FHA appraiser; 5) A completed form HUD-90038 to show that the seller met with an HUD approved housing counselor; 6) A completed Application to Participate Pre-foreclosure Sale form HUD-90036. On approval of the short-sale, HUD will issue an Approval to Participate . . . form HUD-90045.
PDF file copies of the HUD forms mentioned above may be downloaded from the HUD Web site. Adobe® Reader or another PDF application will be necessary to open these documents.
