Why You Should Avoid Foreclosure
When you fail to make your mortgage payments for several months in a row, your lender begins the process of foreclosure in an effort to recoup the debt that you owe them. Foreclosure is a legal process through which your lender can repossess and sell your home to recover the money you owe.
The foreclosure process varies slightly from state to state, but no matter what happens, it will affect your credit score and impact your ability to borrow money. Keep reading for a closer look at the many consequences of foreclosure and tips for what you can do to avoid foreclosure and protect your financial health.
Consequences of Foreclosure
On top of the stress and anxiety that comes with losing your home, foreclosure can have far-reaching consequences that will affect your creditworthiness and financial health and make it challenging to buy a home in the future.
Your Credit Score...
A foreclosure will have a severe impact on your credit score. Your payment history makes up 35% of your overall credit score, and missing your mortgage payments will significantly impact that aspect of your score. And since foreclosure is a more severe mark against your payment history than a late payment, you can expect to see a significant drop in your credit score.
If your credit score falls within the “good” range, a foreclosure will cause it to drop up to 100 points. Meanwhile, those with excellent credit scores could experience drops of up to 160 points. This significant decrease in your credit score will make it harder and more expensive to borrow money for any loan.
A Foreclosure Remains On Your Credit Report For Seven Years
A foreclosure will stay on your credit report for seven years from the date of your first missed mortgage payment. Even though you can likely rebuild your credit score within just a few years, the lingering foreclosure record will continue to affect your chances of being approved for loans, rentals, or even jobs. However, you can minimize the effects of this red flag by working to repair your credit and by being upfront with any prospective lenders about your previous foreclosure and the steps you’ve taken to ensure it never happens again.
It Will Be Challenging To Get New Loans
Having a good credit history is a powerful asset when it comes to borrowing money, and a foreclosure is one of the worst red marks you can have on your credit report. It can make it challenging to gain approval for new loans, especially mortgages. This will make it very difficult to buy a new home and a favorable rate, even after you’ve worked hard to repair your credit.
On top of that, after foreclosure, you may be subject to a waiting period before you’re eligible to apply for a mortgage again. The waiting period (also referred to as a “recovery period”) may be anywhere from two to seven years, depending on the type of loan you’re applying for. For conventional loans, the waiting period is generally seven years unless you are experiencing extenuating circumstances such as a divorce or a health emergency.
The Foreclosure Process Can Be Lengthy
Starting from your first missed mortgage payment and ending with moving out of your foreclosed home, the process can take anywhere from a few months to a few years. Foreclosure processes vary between states, with some states settling foreclosures through the court system and others using a power of sale clause, allowing foreclosures to be settled outside the courts. Foreclosures settled through the court system are known as judicial foreclosures and typically take much longer than “power of sale” foreclosures.
The average foreclosure timeline varies from quarter to quarter. In the first quarter of 2022, the average timeline was 917 days.
Interest Rates Will Be Very High
Because foreclosure will cause a serious blow to your credit report, you will face high interest rates until you manage to repair your credit. This means it will be more costly to borrow money for any loan, whether a credit card, a car payment, or a future mortgage. You may have to work within a tighter budget than you would otherwise because a more considerable portion of your money goes toward interest payments. It may take you longer to repay loans and restrict the amount you can realistically afford to spend on purchases like a vehicle or a new home.
Tax Consequences
In addition to harming your credit score, foreclosure has significant tax consequences. Unless you have also declared bankruptcy, the IRS considers any money that you borrow and fail to pay back taxable income (your lender usually reports this on a form called Cancellation of Debt). That means that when you go through foreclosure, the balance of your mortgage that you are no longer required to pay will be taxable. And, if you receive any profits from the sale of your home, you will be subject to capital gains tax. These additional taxes only add to the financial strain caused by foreclosure.
Tips for Avoiding Foreclosure
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Enter A Repayment Program
If you’re struggling to keep up with your payments, you may feel like your lender is working against you, but in reality, neither of you wants to go through the foreclosure process. It is long and tedious for both parties. Contact your lender and let them know that you’re struggling to stay on top of your payments. They may be able to create a plan for you that will enable you to adjust your payment schedule while avoiding any late payments. Even if you’ve already missed a payment, your lender can likely help you get back on track. You may be surprised to realize how willing your mortgage lender is to work with you to avoid foreclosure!
Forbearance Agreement
Mortgage forbearance is an agreement with your lender that permits you to defer your mortgage payments for a short time while you work to regain financial stability. If you’ve recently lost your job, this can be an excellent way to give yourself some breathing room while you work to find a new one.
When the forbearance agreement ends, the mortgage payments you deferred will come due, so you’ll need a plan to make the payments. Your lender will likely help you create a payment plan, or, if possible, you can make a lump-sum payment.
Refinance Your Mortgage
Refinancing may enable you to lower your monthly mortgage payments and make it easier to stay on top of them. There are many ways to go about refinancing, and the option that is right for you will depend on various factors, including your income, credit score, and more. If you refinance your outstanding mortgage balance over a longer term, you will lower your monthly payments but pay more in interest in the long run.
You may also consider a short refinance, which means you refinance your mortgage for a lower amount of money to lower your monthly payments. Since short refinancing means you’re not paying your original mortgage as agreed, your credit score will likely be negatively affected, but not nearly as seriously as if you go into foreclosure.
Arrange A Short Sale
When you’re unable to keep up with your mortgage payments and the possibility of foreclosure is looming, a short sale can be an excellent way to protect your credit score and avoid foreclosure. In a short sale, you sell your home for less than what you owe on your mortgage, and the lender will either forgive the difference or force you to pay it through a deficiency judgment. While this strategy isn’t ideal, it does mitigate the damage to your credit history, which will make it easier to bounce back from the short sale.
Sign A Deed In Lieu Of Foreclosure
You may be able to avoid foreclosure on paper by signing your home over to your mortgage company in lieu of foreclosure. In the end, you still give up your home, but you protect your creditworthiness in the process, making it easier to recover from the blow.
Consider Filing For Bankruptcy
Filing for bankruptcy is a last resort, but it could be beneficial if you are determined to keep your home. When you file for Chapter 13 bankruptcy, you can keep your home by entering into a repayment plan. The repayment plan will typically take three to five years. Because you must still make payments, this option will likely only work if you have a steady income.
The Bottom Line
Foreclosure is a scary prospect, but it’s essential to realize that you have options. If you’re having trouble making your mortgage payments reach out to your lender and ask if they have any options to alleviate your financial burden. Ultimately, neither you nor your lender wants to go through foreclosure. Being proactive when money is tight will help you keep your home and protect your creditworthiness moving forward.