Life throws unexpected curve balls at everyone and sometimes good people come upon hard times. There are few realizations worse than figuring out you can’t afford your mortgage payment. It took forever to find the right home. You finally have some of the remodeling done, and now you suddenly realize you can’t afford the payment. You don’t know if the bank is going to put you and your family on the street. You are scared, overwhelmed and confused.
To make matters worse, you have all sorts of people telling you that they can help you but you are not sure who to trust. In McHenry or Lake County, Illinois, if you are a few months behind on your mortgage payment, your default is probably a public record and you will receive a tidal wave of solicitation letters from bankruptcy attorneys, foreclosure attorneys, loan modification companies and realtors. Everyone is telling you that they can solve all of your problems, but there is so much conflicting information, it is hard to figure out what to do.
It is hard to figure out what to do because everyone’s situation is different and there is no easy on size fits all solution. To make matters worse, sometimes situations change in the middle of the process and you have to change your plan of attack. To find the right solution and to make sure you are going in the right direction, you need to understand all of your options and how they can help you get relief. You also need to verify that the solution you are working towards does not have any unanticipated income tax consequences.
Here is a list of the five major options for every distressed homeowner (in Illinois):
Foreclosure
Even though this happens when you don’t pay your mortgage, I list it as an option because it can be used to craft a solution. In illinois, for a residential property, the legal part of the foreclosure process can easily take from 9 months to over a year (sometimes even longer). Trying to work something out with your lender (things like a loan modification, short sale or deed in lieu) does not necessarily stop the foreclosure process. It is important to aggressively pursue a solution and to finalize the deal before the sheriff’s sale (auction) of your home. If you are not sure where you are in the process, you can contact a local foreclosure attorney to help you figure out how much time you have.
If you raise a defense (usually with the help of a foreclosure attorney) and your lender wants to settle in court, there are two common ways a foreclosure case is settled.
One way residential foreclosure cases are settled, are by a consent foreclosure. This is where you agree to let the bank proceed with the foreclosure in exchange for a deficiency waiver. A deficiency waiver is a written agreement from your lender acknowledging that you do not owe them any more money. It is important to note that if you have more than one mortgage or lien on the property, a consent foreclosure does not usually include a deficiency waiver from second mortgages and other lienholders. This means if you owe them additional money, they can still come after you.
Another way residential foreclosure cases are settled are by shortening the redemption period (speeding up the foreclosure). This is also usually done in exchange for a deficiency waiver.
At the end of the day, if you are fighting or negotiating with your lender in foreclosure court, you may be able to settle with them and avoid liability for any additional money after the foreclosure (solve the financial problem). But, it may not work if you have multiple mortgages.
With a consent foreclosure or a shortened redemption period, you still end up with a foreclosure on your credit. This can reduce your credit score and can extend the amount of time you need to wait to qualify for another mortgage.
Deed in Lieu of Foreclosure
A deed in lieu of foreclosure is an agreement between you and your lender where you agree to give them the deed to the property (and clear title) in exchange for a deficiency waiver. For most lenders, you need to apply for this using paperwork similar to a short sale (usually a uniform borrower assistance form) which typically also includes: a financial statement, bank statements, paystubs and tax returns. Once your lender has all of your paperwork, they will usually have a Realtor verify what the value of your property is (commonly called a Broker Price Opinion, abbreviated as a BPO). The processing time (time to get an answer from your lender) varies wildly. Some lenders can give you an answer in 30 days and others can take 6 months or even longer.
Because your lender wants a deed with clear title, if you have a second mortgage or other liens (homeowner association liens, municipal liens, etc.), some lenders will require you to negotiate with the other lienholders (or creditors) separately. This means that your primary lender will either require you to get the liens released or will authorize you to offer them an amount less than you owe to get them to release their liens.
If your lender approves you for a deed in lieu of foreclosure settlement, it is very important to verify that the deficiency waiver is in the final paperwork. This way you have written proof that you do not owe your lender any more money. If you are still living in the property, you can also ask your lender for relocation assistance (commonly referred to as cash for keys). If your lender agrees to give you any money back, it is also important to get it in writing before you move out.
A deed in lieu of foreclosure is usually reported on your credit as a settlement. I’ve asked many credit counselors and lenders what the difference is between a deed in lieu of foreclosure and a short sale. I have always received conflicting answers. Most experts agree that a deed in lieu of foreclosure is not as bad for your credit as a regular or consent foreclosure. Some experts say that a deed in lieu is reported as a settlement the same as a short sale and others say that a short sale is more favorable on your credit. If this issue is important to you, the best person to ask for guidance on this is the lender you want to get a loan from in the future. At least this way, if they want to get you a loan in the future, they have a strong incentive to give you the best advice they can.
Loan Modification
A loan modification is another form of agreement with your lender. It is an agreement that changes the terms of the loan. It can change the payment, interest rate, amortization or any other term of the loan. Like a deed in lieu of foreclosure, in Illinois, a loan modification is not a legal right. It is a potential settlement option that can be used if both you and your lender agree to it. There are some federal programs that offer lenders incentives for loan modifications. Some local non-profit credit or housing counselors are familiar with these programs and can help with loan modifications. (An example Is Consumer Credit Counseling Services.) Having a local credit housing counselor review your loan modification paperwork can be a huge benefit because they can help you figure out what you can afford and may be able to review your loan modification paperwork.
If your hardship is only temporary, your lender may be able to work with you on a forbearance agreement. A forebearance agreement is an agreement with your lender to temporarily reduce or skip your mortgage payment to accommodate a temporary hardship. Your lender can charge you additional fees for this and you usually have to pay back all of the missed or reduced payments. If you are pursuing this option, it is always best to have the exact terms in writing, so you know when you have to go back to making your payment and what your lender is doing with the additional fees and money you owe them.
Bankruptcy
Bankruptcy is a way to eliminate or restructure your debt. For most homeowners there are two different types of bankruptcy relief to explore.
The first one is a chapter 7 bankruptcy. In a chapter 7 bankruptcy, you file a petition with the court and if it is granted your debts are discharged (meaning you don’t have to pay them back). Once you pay your attorney and your filing fee, you usually do not have to make any additional payments for a chapter 7 bankruptcy. There are limitations on the types of debt you can get rid of and limitations of the assets you can keep. A local bankruptcy attorney can help you figure out if you can get rid of all of the debts that are a problem and keep all of your stuff (assets).
For a distressed homeowner (someone who cannot afford their mortgage payment), a bankruptcy discharge can get rid of the personal liability on the loan(s) on your home, but it does not usually release the lien from the property. This means if you don’t pay your mortgage, your lender can foreclose and take the house, but you don’t usually owe them any money after the foreclosure is complete. For some homeowners, this means you can stay in your home during the foreclosure process (usually at least 9 months to a year) and save up money for your fresh start.
The second form of bankruptcy that most distressed homeowners consider is a chapter 13 bankruptcy. A chapter 13 bankruptcy requires the person filing to pay back some of their debts. Most repayment plans are either for 3 years or 5 years depending on your assets and income. A good chapter 13 attorney should be able to give you a ballpark estimate of what your monthly payment would be and how many years will need to make payments. At the end of your repayment plan, any debts that were not paid in full and were included in the bankruptcy (with some limited exceptions) will be discharged.
If you are temporarily behind on your mortgage, you can afford to go back to making your monthly mortgage payments and can afford to pay back the amount you are behind, you may be able to use a chapter 13 bankruptcy to keep your house. You can repay the arrearage (the amount of money you are behind) as part of your bankruptcy payments. This is where a chapter 13 bankruptcy could save your house and get you out of foreclosure.
Filing bankruptcy can get rid of your personal liability for your loan or get you additional time to catch back up, but it does not force your lender to let you keep your house. Most bankruptcy courts cannot modify your mortgage agreement itself without your lender’s agreement.
Short Sale
A short sale is the sale of your home for less than you owe. Just like a deed in lieu of foreclosure, it is an agreement you can negotiate with your lender. A short sale is a way to work with your lender to sell the house and minimize both of your losses. Most lenders require you to list your home on the open market with a licensed Realtor before they will consider an offer. Once you accept an offer your Realtor, or your real estate attorney will present the offer to your lender(s) and try to negotiate their approval. Once the bank approves the short sale, your buyer finalizes their mortgage (or gets their cash ready if they are not taking out a loan) and you move out of the home before the closing.
The “short” part of a short sale is the payoff to your lender not the time it takes to complete. Processing times for short sale requests can range from as fast as 30 days or can exceed 6 months.
If you want to do a short sale and you want to make sure you don’t owe the bank any more money, it is very important to make sure that the short sale approval has a deficiency waiver. Some short sale lenders will offer relocation assistance as part of the short sale. There is no legal right to relocation assistance, so your lender does not have to give it to you. Additionally, if your lender approves relocation assistance, you do not get the money until after you move out and after the closing. So, it is more accurate to call it relocation reimbursement.
From a credit standpoint, a short sale is the settlement of your debt(s) with your lender(s). It is not reported as negatively as a foreclosure. I get conflicting answers from credit counselors and lenders on whether a short sale is more favorable on your credit then a deed in lieu of foreclosure. If you are concerned with this, the best person to ask is the lender you would like to get a loan from in the near future.
Note: The following information is not tax advice. If you are working on any of the above-mentioned options, it is important to get tax advice on income tax consequences of any of these options from a local accountant or tax preparer.
The last major issue you have to be aware of is IRS Income tax issues relating to any of the previously mentioned options. Any time you borrow money and don’t have to pay part of it back, the lender usually needs to report their “forgiveness” of that debt to the IRS. This could count as income to you.
