Mortgage Default: What You Need To Know
When times are tough, it can seem impossible to keep up with all your bills. However, if you don’t make your monthly mortgage payments, you risk facing mortgage default and potentially losing your house.
Such events are catastrophic but can be prevented if you know the appropriate steps to take. Let’s learn more about what defaulting on a mortgage means and how you can avoid doing so to protect your home and your finances.
What It Means To Default On A Mortgage Loan
Mortgage default arises when a borrower fails to make monthly payments on a home loan. Defaulting can also occur with credit cards and student loans. When a borrower repeatedly misses payments or stops making them altogether, there can be serious ramifications both in the short and long term.
A mortgage default can cause a borrower to lose their house and damage their credit score. In the long run, defaulting can also increase the borrower’s interest rate on other debts and make it challenging to qualify for a future loan.
How Does A Loan Default Happen?
While missing monthly payments is the most common way for a home loan default to occur, it’s not the only one. Homeowners can also go into default if they:
- Fail to pay their property taxes
- Fail to pay their homeowners insurance
- Transfer their home’s title to a new owner without their lender’s permission
- Are discovered to have purchased the property through illegal means or are currently using the property for illegal purposes, like drug trafficking or money laundering
What Happens If I Go Into Mortgage Default?
If you go into mortgage default, you’ll be given the opportunity to apply for loss mitigation options before your lender takes control of your property. However, if you fail to reach out to your lender, you can expect to experience the steps discussed below.
Your Lender Accelerates Your Debt
If you are over 30 days past due on your mortgage, it’s possible that your lender may invoke the acceleration clause in your mortgage contract. Through this clause, your lender can accelerate the debt and request that you immediately pay the entire remaining balance of your loan. This step makes it easier for your lender to ultimately foreclose on your property.
It’s important to note that it’s unlikely your lender will accelerate your debt immediately if you fall 30 days past due on your loan. Though they could take this route, your lender wants to help you and will make efforts to do so before jumping to invoke the acceleration clause.
Your Home May Go Into Foreclosure
If you don’t have the funds to pay the outstanding balance on your mortgage and you’ve exhausted all other options, your lender will move to foreclose on your house. Though it depends on your state laws, you’ll usually have to be at least 120 days delinquent on the loan before foreclosure proceedings can begin.
You May Lose Your Home
If you’re unable to resolve the default before the foreclosure process is complete, you’ll be forced to leave your home. Once control over your property is transferred to your lender, they’ll auction it off to a new owner to recoup the funds you were unable to pay back.
How To Avoid A Mortgage Default
Defaulting on your loan and losing your home is a scary prospect. However, the foreclosure process doesn’t happen overnight. Even if you’re experiencing financial hardship, there are multiple ways that you can avoid defaulting on your mortgage.
Find Out If You Can Refinance
If you have not yet defaulted, see if you can qualify for a refinance. When you refinance, your existing mortgage gets paid off and replaced with a new loan that has new terms.
The new loan may provide you with a lower interest rate or allow you to extend the term of your loan. Therefore, through a refinance, you can potentially lower your monthly payments and make them more affordable and more manageable. If you can’t qualify for a refinance, the next step is to speak with your servicer to see what other options you may have.
Speak With Your Servicer
If you know you’re going to be unable to make your monthly mortgage payment, speak with your loan servicer immediately. The sooner you reach out, the better your chances of avoiding mortgage default.
When speaking with your lender or servicer, you should explain why you can’t afford the payment now, when you think you’ll be able to and how much you can pay in the meantime. Many lenders are willing to work with borrowers to come up with a solution for overdue payments if you reach out in advance.
Depending on your hardship, you may qualify for mortgage forbearance, a period during which your lender agrees to let you reduce or pause your monthly payments, and help you create a repayment plan.
Consider A Mortgage Loan Modification
A loan modification is an option which can allow you to maintain your current loan but change its terms either temporarily or permanently. The goal of a loan modification is to hopefully reduce your monthly payments to make them more manageable while rolling your past due payments back into the mortgage.
Loan modifications tend to have a larger impact on your credit than refinancing and that impact can be negative, which is important to note. It’s also possible that the change to the rate and term of your mortgage may cause you to pay even more for your home than you originally would have due to the additional interest you’ll pay after rolling your past-due payments back into the loan.
It’s important to talk to your servicer to determine whether this option would be beneficial for you in the long run.
Sell Or Apply For A Short Sale Or A Deed In Lieu Of Foreclosure
In the event you find none of the options above work out, you may still have a few additional options to avoid loan default: sell your home, apply for a short sale or apply for a deed in lieu of foreclosure.
While it may be a difficult choice to make, selling your home may be the best solution when making payments is no longer affordable. This way, you can ideally get back any equity you’ve earned before it’s lost to foreclosure.
If you can’t sell your home the traditional way, you might apply for a short sale. With a short sale, you and your lender could agree to sell the home for less than the amount owed on the mortgage. The proceeds from the sale would then go towards your loan balance and, depending on the terms agreed to, the lender either forgives the rest or requires the borrower to pay back the amount remaining on the loan. Though you sell your home at a loss with a short sale, it’s still a better option than foreclosure because it will be less damaging to your credit.
With a deed in lieu of foreclosure, the borrower voluntarily gives up the deed to the house to the lender in order to avoid foreclosure. If you hope to be a homeowner again in the future, a deed in lieu of foreclosure would allow you to apply for a new conventional loan in 4 years. The waiting period differs for government backed loans – VA loans may allow you to apply again in 2 years, for example.
If you don’t go this route and your home goes through foreclosure instead, you’ll likely have to wait 7 years before seeking a new mortgage, since the foreclosure will remain on your credit report for that time.
The Department of Housing and Urban Development (HUD) has counselors who can examine your financial circumstances and try to help you find a solution that will hopefully enable you to avoid defaulting on your loan.
There are a variety of state and federal programs that assist borrowers in danger of defaulting. A HUD counselor can explain your options to you, help you select a program that’s best suited for your needs and speak to your lender on your behalf.
The Bottom Line
The thought of defaulting on your home loan can be terrifying, but don’t let it prevent you from taking action. Even if your monthly payment is already past due, you can still take steps to avoid foreclosure. Contact your lender as soon as you realize you may be in danger of missing a payment, and they will help you find a solution.
If you're considering a mortgage refinance to avoid a loan default, start your application today.