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Getting Out of Debt

Fighting a Foreclosure

The feds haven't been much help so far. You're better off negotiating with your lender.

Nearly 2.4 million homeowners have lost their homes to foreclosure since the housing market turned south in 2006, and that number is expected to climb to six million before the bust is over.

First to succumb were the investor flippers, who turned their keys in to their lenders to cut their losses. Next came the below-prime adjustable-rate-mortgage borrowers, whose interest rates jumped to unaffordable levels. Now the foreclosure bug is infecting the 12 million homeowners who are "underwater" because they owe more on their mortgage than their home is worth -- a group that includes prime borrowers who had top-notch credit. They all won't lose their homes, but if they suffer a job layoff or other financial hardship, "they're toast," says Mark Zandi, chief economist at Moody's Economy.com.

Simply stated, if you can't make your payments, can't sell and can't refinance, you're flirting with foreclosure. Every state has its own rules and timeline, but lenders generally start the foreclosure process three to six months after you miss a payment.

If you're determined to keep your home, you'll probably need to ask your lender to modify your loan terms. Or you could file for Chapter 13 bankruptcy with a plan to repay your debts, including your mortgage. If you can't make the numbers work, you can give up your home but avoid foreclosure through a short sale or by using an alternate strategy called deed in lieu of foreclosure. Those options may offer a psychological lift and help reassure future creditors about your motivation to repay. They also allow you to qualify for another mortgage sooner than if you had gone through foreclosure.

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When plummeting home values sent Lori and Andy Saczynski of Destin, Fla., down the road to foreclosure, they decided to bail. They bought their three-bedroom home in May 2005, just as the local market peaked, for $292,000 with 100% financing -- a 70% first mortgage and a 30% second mortgage. They expected to sell the house for a profit in just a few years so that they could build their dream home. When the market began its free fall, they hung on, hoping it would recover.

Meanwhile, Lori and Andy both worked -- Andy at two jobs totaling about 80 hours a week. They also cut back on everything they could to continue making their monthly payment, which rose twice with interest-rate adjustments. The last straw was when Lori got laid off. Lori says that she and Andy weren't raised to "walk away from our debts," but they also knew they couldn't sustain the mortgage payment.

They asked real estate agent Wendy Rulnick to help them with a short sale -- selling the property for less than the amount owed on the mortgage. It took three months to get an offer -- for $180,000 -- and another couple of months for the bank to accept it. The first-mortgage holder accepted a loss of about $24,000. The second-lien holder was out about $85,000. Since then, the couple and their three children -- Taylor, 11, Nathan, 6, and Noah, 1 -- have moved into a home that Andy's dad bought for them. Lori and Andy are paying him back.

Help From the Feds
The federal government has talked a lot about stemming the tide of foreclosures, and most policymakers agree that keeping people in their homes is better for the housing market. But the feds haven't provided much help so far. The programs introduced are so narrowly focused that they leave out a lot of homeowners who could use help, says Guy Cecala, publisher of Inside Mortgage Finance newsletter.

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Last October, the Federal Housing Administration launched the Hope for Homeowners program to help underwater homeowners refinance. But mere hundreds of homeowners have been helped, and few lenders have climbed aboard.

In November, federal agencies and the Hope Now coalition (made up of 27 lenders and nonprofit consumer organizations) announced a program to bring "affordable" loan payments to borrowers who live in their homes, have missed three or more payments and haven't filed for bankruptcy. Any reduction in principal on the front end of the loan modification would be paid at the end of the loan.

Major retail banks, such as Bank of America (which bought Countrywide), JPMorgan Chase (which bought Washington Mutual and EMC) and Citi, have announced their own programs, and so has the Federal Deposit Insurance Corp. (for IndyMac borrowers). All of them are aimed at homeowners who are already in trouble or may soon be, as long as the home is their primary residence. All told, it's estimated the programs might reach out to more than a million homeowners. And FDIC chairwoman Sheila Bair has proposed implementing more widely her agency's model of loan modification.

One FHA refinancing program that has enjoyed reasonable success is FHASecure, which has helped more than 460,000 homeowners since the fall of 2007. In early December, Fannie Mae announced more good news for homeowners: It would direct its loan servicers to help borrowers as soon as they demonstrate the need for help, even before they're delinquent.

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If you're a member of the military or a veteran, you have special rights regarding mortgage interest and foreclosure under the Servicemembers Civil Relief Act. For more information, visit www.homeloans.va.gov/veteran.htm.

Homeowners age 62 or older may be able to take out a reverse mortgage to pay off outstanding debt. For more information, visit HUD.

Call Your Lender
If you're in trouble, don't wait for someone to lend a hand. As soon as you think you may miss a payment, call your lender or loan servicer to establish that you are a responsible homeowner who wants to do the right thing. If you're lucky -- and especially if your setback is temporary -- your lender will offer a solution.

When you're behind in your payments because of a temporary loss of income, lenders will typically offer a repayment plan -- once your income resumes -- in which you pay extra each month, usually for up to two years. If you anticipate that you won't be able to make payments temporarily but you have a good record with your lender, it may propose a forbearance plan of up to 18 months during which you make no payments or reduced ones, followed by repayment later. You can also negotiate with your lender for a longer-term loan modification to make your mortgage more affordable.

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You can call your lender yourself (and ask for the loss-mitigation department), but you'd do well to ask a certified housing counselor to mediate on your behalf. Mary Ellen Nicol, a counselor with Consumer Credit Counseling Service of Greater Atlanta, says counselors have direct lines into the loss-mitigation departments of all the major servicers. (Call the Hope Now hotline at 888-995-4673, or visit www.hopenow.com.)

Counselors such as Nicol are like medics on the front lines of foreclosure, performing budget triage, reviewing worst-case scenarios and sorting out strategies. Nicol looks for big budget offenders, such as a large car loan or excessive cell-phone or cable bills. Trimming those can give clients the cushion they need to handle their mortgage payment. If that's not going to work, she explains the foreclosure process to them.

How to Let Go
Homeowners who can avoid foreclosure only by throwing everything they have at their mortgage payment may be better off letting the home go, says Mesa, Ariz., financial planner Brendan McNamar. That way they avoid working their way through rainy-day savings, running up credit-card balances and failing to save for retirement.

A short sale is one option. Short sales are best conducted by an experienced real estate agent who can negotiate the obstacles imposed by lenders or investors. "To get one approved takes five times as much effort as a normal listing," says Wendy Rulnick, the Destin, Fla., agent who assisted the Saczynskis.

To start, your agent will list your home for sale at about its current market value. "If it's priced too far below the comparables, lenders may accuse you of trying to do a fire sale, and they'll think they could get more money by doing it themselves in a foreclosure," says Elizabeth Weintraub, an agent with Lyon Real Estate, in Sacramento, Cal. For your part, you must prove that you are suffering hardship by providing income and expense sheets, tax returns, bank statements and pay stubs.

Even after a final deal has been negotiated -- not an easy task, given the volume of short sales and the red tape involved -- you still may not get off scot-free. Investors or second-lien holders may demand that you pay some cash at closing or sign a promissory note. If your state allows the lender to sue you to recoup its losses, try to persuade the lender to agree in writing to let you off the hook.

Another strategy, deed in lieu of foreclosure, allows you to sign over your property's deed to your lender, which forgives what you owe. It sounds simple and ostensibly saves the lender the expense of foreclosing; but the lender still ends up having to manage and sell the property. The lender may require you to try to sell the home before agreeing to the deed.

Taxes and Crredit
If you go through a foreclosure, short sale or deed in lieu of foreclosure, the lender will report your mortgage account as "settled," meaning that you agreed to settle the debt for less than you owed. That negative information stays on your credit report for seven years.

You can immediately start rebuilding your credit profile -- and boost your score -- but lenders may choose not to lend to you again within a certain time frame. Fannie Mae and Freddie Mac will not provide mortgages to borrowers for three to five years after a foreclosure, and two to four years after a deed in lieu of foreclosure or a short sale related to a delinquent mortgage.

One bright spot: Last fall, Congress extended through 2012 tax relief on any debt forgiven as part of a loan modification, short sale, deed in lieu of foreclosure or foreclosure, as long as you used that debt to buy, build or improve your primary home. Even though the debt isn't considered taxable income, you'll still have to report the cancellation of debt on Form 982 and attach it to your tax return.