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Alternatives to foreclosure

Contact the lender and ask for the Loss Mitigation Department. Loss Mitigation is about stopping foreclosures and helping homeowners save their home

When a borrower is unable to pay but the problem is temporary, the lender has an interest in finding a way to help the borrower ride it out. A tool for this purpose is a forbearance agreement combined with a repayment plan.

A forbearance agreement means that the lender suspends and/or reduces payments for a    period, usually less than 6 months, although it can go longer. At the end of the period, the repayment plan kicks in. The borrower agrees to make the regular payment plus an additional agreed-upon amount that will cover all the payments that were not made during the forbearance period. The repayment period is usually no longer than a year.

When successful, the borrower is brought current after a lapse, and the lender suffers no loss. However, a lender will only consider this approach if convinced that the borrower's problem is temporary. The burden of proof is on the borrower.

If a borrower's income has been reduced to the point where they can't pay the current mortgage but could pay a smaller amount, the lender might consider a loan modification. This could be a lower interest rate, longer term, a different loan type, or any combination of these. Unpaid interest may be added to the loan balance.

A lender is likely to be most receptive to a loan modification where the borrower has little equity in the house, but wants to keep living there. With no equity, foreclosure would be costly. But the lender must be convinced that the borrower's inability to pay is completely involuntary.

If the borrower's inability to pay is long-term and the borrower is resigned to giving up the house, the lender will consider several alternatives to foreclosure. If the borrower has a qualified purchaser who will take title in exchange for assuming the mortgage, the lender may allow it. This is called a workout assumption

Alternatively, the lender might allow the borrower to put the house on the market and accept the sale proceeds as full repayment, even though it is less than the loan balance. This is called a short sale

If the borrower is unable to sell the house, the lender might accept title to the house in exchange for discharge of the debt. This is called a deed-in-lieu of foreclosure

Knowing what a lender can do is useful, but it does not tell you what a particular lender will do in any specific situation. Lenders differ in how they respond to payment problems. It may depend on whether they own the loan or merely service it. It may also depend on who takes your call.

I have always advised borrowers having payment problems to approach the lender before they become delinquent.

Borrowers in trouble should develop a game plan before they become delinquent. Step one in that process is to develop a realistic understanding of the position of the lender, as discussed above. While some actions you can take on your own, such as selling your house, other actions have to be negotiated with the lender. You do better in any negotiation if you know where the other party is coming from.

Step two is to document your loss of income. This will position you to demonstrate to the lender that your inability to pay is involuntary, should this be necessary later on

Step three is to estimate your equity in the house. Your equity is what you could sell it for net of sales commissions, less the balance of your mortgage. This will help you develop a strategy for dealing with the lender.

Step four is to determine realistically whether your financial reversal is temporary or permanent. A temporary reversal is one where, if you are provided payment relief for up to 6 months, you will be able to resume regular payments at the end of the period, and repay all the payments you missed within the following 12 months. You must document the case for the reversal being temporary. If you cannot make a persuasive case that the change in your financial condition is temporary, the lender will assume it is permanent.

If you have substantial equity in your house, the least-costly action to the lender may be foreclosure. While foreclosure is costly, the lender is entitled to be reimbursed from the sales proceeds for all foreclosure costs plus all unpaid interest and principal.

While foreclosure makes the lender whole, it is a disaster for you. Your equity is depleted, you incur the costs of moving, and your credit is ruined. Hence, you must avoid foreclosure, if necessary by selling your house.

If you have little or no equity, your bargaining position is actually stronger because foreclosure is a sure loser for the lender.

If your financial reversal is temporary, and assuming you want to remain in your house, it will be easier to persuade the lender to offer payment relief than if you have equity.

If your financial reversal is permanent, but not major, the lender may be favorably disposed to a contract modification that will permanently reduce the payments.

If your financial reversal is permanent and major, the lender probably will be willing to accept either a "short sale" or a "deed in lieu of forclosure". In the first, you sell the house and pay the lender the sales proceeds while in the second the lender takes title to the house. In both cases your debt obligation usually is fully discharged. They do appear on your credit report, but are not as bad a mark as a foreclosure.