I Can’t Pay My Mortgage Any More. What’s Next?

”In these uncertain times…”

Person standing, looking out a window contemplating how they are unable to pay their mortgage.

Difficulties arise in life, sometimes out of the blue. Mortgage obligations that suited us just fine at first can become unmanageable when circumstances swerve out of control. At that point, a homeowner might approach the mortgage lender and ask for a few months of forbearance. Or perhaps it’s possible to work out a repayment plan, or get a loan modification. Sometimes, the homeowner’s financial stress is too serious for any of those options to apply.

Consider that the homeowner must resolve two obligations on the mortgage loan: the lien, and the promissory note, which is the promise of repayment. If an owner cannot keep that promise, the lender is allowed to recover and sell the house.

How Can I Keep My House? What Are My Options?

Filing for Chapter 13 bankruptcy with a plan to sell the home is one way around foreclosure — although it’s hard on a credit report.

The homeowner should also consider whether the house can be profitably rented out. Yes, this income will be taxed. And being a landlord comes with its own set of challenges, although there are professional managers who can take on the role. And your management and repair expenses as a landlord will be deductible.

But using a house for income is not ideal for everyone. There are several other ways to work with the property when a loan gets overwhelming. Here, we explore several common options.  

Will the Bank Take the House Off My Hands? The Deed in Lieu of Foreclosure

One option is the deed in lieu of foreclosure. This is a voluntary, binding transfer of title from the homeowner to the mortgage lender in exchange for an immediate release from the mortgage.

The lender, if it accepts the deed in lieu, winds up with the task of selling the home. So, as a general rule, lenders do not want deeds in lieu.

When it’s allowed, a deed in lieu lets the lender and the debtor avoid the very costly and time-consuming procedure of foreclosure. While some homeowners in the pre-foreclosure stage might prefer to stay in the foreclosure fight in order to buy time to gather funds to keep their homes, others have limited financial options and need to get on with their lives. If an owner has just the one mortgage to deal with and relatively little equity built up in the house, the deed in lieu might be a sound option.

How is a deed in lieu started? The homeowner calls the mortgage company to ask for a loss mitigation application. The next step is to submit the application, including a statement on the hardship and detailed information on income and expenses. The lender will either force the owner to list and attempt to sell the home first, or green-light a deed in lieu to avoid foreclosing.

An owner who gets the go-ahead for a deed in lieu will sign over a deed, transferring ownership of the property to the lending institution. The owner must give both the deed and keys to the lender. More details appear here.

A deed in lieu (as opposed to full foreclosure) can shorten the waiting period imposed on the homeowner before any future mortgage approvals will be allowed. And in most cases, the lender releases the borrower completely. Yet some lenders will send the credit bureaus a report of deficiency — value they couldn’t recover when they finally sold the house — as well as reporting the deed in lieu. For their own protection, we recommend that homeowners have an in-depth discussion with the lender, and with a tax adviser or attorney, before transferring a deed in lieu.

IMPORTANT: To avoid a lawsuit — yes, the lender can sue — for a deficiency judgment, a deed in lieu agreement must expressly state that the transaction is in full satisfaction of the debt.

A Short Sale — and a Catch-22

What about a short sale? First, a lender must agree to one. This will only happen if the owner faces a level of financial distress that rules out paying the mortgage. And note that for a property with multiple mortgages, all lien holders have to agree to the sale.

In a short sale, the lender:

  • Accepts a borrower’s loss mitigation application and proof of financial distress. 
  • Lets the borrower sell the house for less than the total debt remaining on the mortgage.
  • Accepts the proceeds, releases the lien, and halts the foreclosure.

Like a regular real estate deal, a short sale is handled by an agent. But a short sale is a prolonged, costly process. While the seller waits for the bank to approve an offer, the bank might press the buyer for a higher bid. Don’t be surprised if the sale takes up to a year to get to closing. 

The short sale comes with additional built-in challenges for a homeowner in financial distress, too. While it removes the mortgage lien, it doesn’t nullify the promissory note the buyer signed. So, some lenders expect to collect more money after closing. This is not the case everywhere; though. For instance, California law bars a deficiency judgment following a short sale. And no deficiency is counted against the homeowner if the bank waives its option to reimbursement for the shortfall.

Now here’s the Catch-22. If the lender forgives a deficiency and issues a 1099-C for cancellation of debt, the debt forgiveness may need to be declared as income. Tax rules change often; talk with a tax specialist about the consequences of applying for foreclosure alternatives. A short sale attorney can help the seller throughout the process.  

When the Deed Meets Foreclosure

When the real estate market goes down, a home can turn into a burden. Some mortgage holders decide that they simply cannot pay. What are the consequences? A significant FICO score drop, and a waiting period before getting another mortgage. What happens next? A collections process, after three months. In about a year and a half, the lender will foreclose.

A search for “non-recourse states” will tell you if your state bars deficiency judgments after foreclosure. Where such judgments are barred, some homeowners opt, for that very reason, to let the home go into foreclosure, knowing they’ll have protection from these judgments. In states that can recover deficiencies, a lawyer can help negotiate the payment.

Once foreclosure starts, what happens to the deed? Depending on your state, the title must be transferred through a trustee’s sale or a county sheriff’s sale, through which the bank tries to recover at least some of the outstanding mortgage debt. Special warranty deeds are common in forced home sales. A lender selling a property will not wish to guarantee the whole history of the title, preferring to leave cleaning up the title to the new owner.

Now you might ask: Can I buy my own home at a discounted price, once it is listed for a sheriff’s sale? The answer is yes. If you buy a foreclosed house, here’s what you need to know:

  • It might not be enough to submit the highest bid. Loan servicers have some discretion in selecting a bidder who is likely to go through with the purchase by the period of time allowed in the county.
  • A municipal lien search will show you claims that survive foreclosure — including, upon request, any unrecorded liens.
  • Abandoned or expired mechanics’ deeds need to be cancelled by the parties that filed them to clear title.
  • The buyer must resolve outstanding utility bills, code violations, and open permits. An attorney can help a buyer negotiate the costs.

After foreclosure, how long is the waiting period to qualify for a new mortgage loan? Seven years for a conventional loan, but it can be as little as three to four years if there are extenuating circumstances — which is comparable to the waiting period after a deed in lieu or short sale. FHA mortgage insurance becomes available in just three years after foreclosures, deeds in lieu, or short sales.

What About Tax Deed Sales?

When real estate taxes go unpaid, the homeowner receives a tax lien certificate. State law controls the payoff timeline, and an owner may be able to get on a payment plan. After the payoff, a release must be recorded in the county.  

Ignore the certificate, and ultimately the home could wind up at a public auction. Assuming the taxes aren’t paid off at the last minute, an investor can bid for the tax deed. Tax deeds come with clouded titles. To clear title, a buyer can undertake a title certification, in which a curative consultant works with a title insurer to clear the title.

What about federal liens? A federal tax lien is not a levy, and doesn’t lead to an immediate seizure of property. But it must be resolved, or it ties up the title. What should the buyer do? Call the IRS, which offers payment plans and withdrawal options for federal tax liens. These liens are credit history blemishes for seven years, unless a one-time resolution through the IRS Fresh Start Program applies.

If the property winds up in a tax lien sale, liens that aren’t satisfied through the sale proceeds might be able to be released or subordinated, with a tax lawyer’s help.

There’s no time like the present to make sure your federal, state and local taxes are all up to date. As the saying goes, the only thing worse than paying taxes is not paying taxes!

Photo credit: Ethan Sykes, via Unsplash.