If you face overwhelming debt and own a home, you are undoubtedly worried about home foreclosure. Perhaps you are one step away from missing a mortgage payment — or you're already behind and the bank has come knocking on your door.
Here we try to ease your worry and explain, in concrete terms, your likeliest options if you find yourself facing home foreclosure. There are typically three:
Let go of your home and rent an apartment or downsize
Stay in your home and attempt a loan modification with your lender
Stop home foreclosure through bankruptcy
Let go of your home
You probably see this as your least attractive option — and with good reason — especially if you've been in your home for years and perhaps have built equity. Losing your home to foreclosure — being forced to leave — is not something you imagined. But it happens.
Walking away from your home has come to be known as "strategic default," where the typical homeowner is underwater; the price of the mortgage far exceeds the value of the home in the marketplace and servicing the debt is no longer economically feasible. A decision is made to pack and leave.
If you let go of your home, the bank may sue you for the mortgage deficiency (or "shortfall") — the difference between the balance of the mortgage loan and what the bank recoups at the sheriff's sale. If your home was significantly devalued after the housing bubble burst in 2008, it's likely that there will be a shortfall.
The bank may or may not sue you, and whether or not you get sued often depends on where you live. Some states have laws against collecting shortfalls; other states do not. You can usually eliminate shortfalls through bankruptcy, but by then you've already lost your home. And if your home wasn't underwater and you had equity after years of payments, you've lost the equity, too.
Ultimately, no one can force you to stay in your home and find the money you need to pay your mortgage, not even your lender. For better or for worse, that is the essence of strategic default.
Attempt a loan modification
The banks have been pressured to negotiate mortgage loan modifications (and scores of supposed "debt settlement" firms offer to negotiate on your behalf). It's possible to obtain a favorable loan modification, but not likely.
First, do not hire a debt settlement firm unless it is thoroughly reputable. Many of these so-called firms take your money and do nothing. In the wake of the Great Recession, the Chicago Tribune reports that it's "a perfect storm for debt settlement companies, which promise you the moon but rarely deliver." It would be better to call a nonprofit credit counseling agency (which you are required to do anyway in bankruptcy).
Second, the banks haven't been very flexible with modifications in a foreclosure mess that, according to Robert Scheer when writing for The Nation, has affected more than 20 million Americans. Scheer describes the "robo-signing" scandal, in which a computerized system — rather than real human beings — handled crucial mortgage documents and is now adversely affecting the process.
You should always try to obtain a loan modification. Keep in mind, however, that the outcome is uncertain and will not definitely stop home foreclosure, especially if you are struggling to pay other debts like credit card balances and medical bills.
File for bankruptcy
In our opinion, the best weapon against home foreclosure is bankruptcy. The automatic stay is a provision in bankruptcy law that requires your creditors to cease their collection and foreclosure efforts after your attorney files your bankruptcy petition.
The mortgage lender, for example, must stop its efforts to foreclose on your home. This is not a permanent stop to foreclosure, but the automatic stay will typically at least delay foreclosure proceedings while your bankruptcy is pending. Then, what happens after bankruptcy depends on your situation.
With a focus on preventing foreclosure for the homeowner, we outline the two typical paths below:
- Chapter 7 bankruptcy: If you're not too far behind on your mortgage and have the ability to keep up with mortgage payments after discharging unsecured debt (credit cards, medical bills, etc.), then this path is generally the least time-consuming and most advantageous. You must, however, qualify under the means test based on your income and the nature and amount of your debt.
- Chapter 13 bankruptcy: This type of bankruptcy is otherwise known as reorganization. Your attorney will negotiate with the mortgage lender to create a three- to five-year repayment plan in which you pay back a portion of what you owe. This is the most typical path for homeowners who want to keep their home and other secured assets, and do not qualify for Chapter 7.
In the end, debt settlement firms simply do not have the leverage of a law firm that is prepared to seek debt relief in bankruptcy court. And inflexible mortgage lenders are essentially forced to negotiate in good faith (more or less) when the homeowner files for bankruptcy. If you're facing home foreclosure, the help of a lawyer can go a long way toward keeping you in your home.