How to Avoid Foreclosure by Reducing Your Mortgage
Created by FindLaw's team of legal writers and editors | Last reviewed June 20, 2016
When times get tough, it is no wonder that many homeowners have to take out second mortgages on their homes, and even home equity loans. Sometimes homeowners choose to take on additional mortgage obligations even in good times in order to gain funds for home improvement projects, business ventures or the like.
Faced with all of these obligations, making monthly payments on these loans can be quite a financial burden. Many people wonder, faced with these difficulties, how to avoid foreclosure or selling their home. In almost every situation, it is best to stay current with the first loan on your home and delay or make reduced payments on the subsequent loans. Usually only the first and second home loan providers have the ability to foreclose on your home.
If it is possible for you to pay the one or two lenders that could foreclose on your home and avoid paying the others, this could help you avoid foreclosure. By doing this, you have more money to pay your primary lenders with and, at the same time, have a better chance of staying in your home.
Here is how it could work for you:
The Basics of Mortgage and Foreclosure:
When you first took out the loan for your home, you probable secured the loan by giving the bank a mortgage or deed of trust on the home you bought. This relationship gives your lender a legal claim to your home. Under the terms of this arrangement, the lender has the power to enforce its legal claim on your home through foreclosure proceedings if you fail to live up to your side of the contract. In order to avoid foreclosure, you must make your payments on the loan. If the lender does foreclose on your home, your home will be sold, either at auction or through a private sale, and the proceeds of that sale will go towards the remaining amount on your mortgage.
Depending upon the state you live in, the legal relationship that you have with your lender will either be in the form of a mortgage or a deed of trust. These terms are generally used interchangeably.
The order and name of a loan is dependant on the when the loan was taken out and in what order it was taken out in relation to the other loans secured by your home. For example, the first loan that is taken out on your home, which is often the loan used to make the original purchase, is called the first mortgage. This mortgage is recorded first and should also be paid off first. If a subsequent loan is taken out on the home, this is called a "second mortgage," and should correspondingly be paid off second. Other loans, called home equity lines of credit, can be taken out and secured by your home as well. As with the other mortgages, the lenders for these additional loans also have the option of foreclosing on your home if you do not pay the loan back.
The name of the loan is not only important for your records, but it is also important for the lenders as well. If your home is foreclosed on and sold, either through private sale or auction, the lenders are paid off in order of the seniority of their loans. This means that the lender on the first mortgage gets paid first, the lender on the second mortgage gets paid next, and so on. Depending on the value of your home, the lenders on a second or third mortgage might not get paid at all in the event of a foreclosure. Because of this system, it makes it more likely that a holder of a second or third mortgage has less incentive to initiate foreclosure proceedings because they may not get paid at all.
Loans Without Enough Equity
In recent years, many banks were willing to lend money to home-buyers who did not have good credit or a sizable amount of money as a down payment. This was because of the rapid increase in home value that was seen across the nation. Banks were reasoning that, even if a home-buyer defaulted on their loan, the bank could recoup all of its losses and more by initiating foreclosure proceedings. For example – a risky home-buyer would come to a bank and ask for a loan to buy a $200,000 home. The bank would do some research and see that the property values in that area were expected to rise at a fast pace in the coming years. Even if the home buyer defaulted, the bank could be secure in its knowledge that it could foreclose on the home and reasonably expect to sell it at auction for $300,000. For a while, this strategy worked and banks were running record profits on their mortgages.
The Real Estate Market Crash
However, the risk finally came back to haunt the banks when property values across the country declined sharply, with homes dropping in value by 50% or more in some areas. These decreases in home value erased much of the equity that had accrued in the real estate market during the previous years.
What does this mean for homeowners that are behind in their mortgage payments?
Many people often wonder how to avoid foreclosure. Because of the recent drop in property value, homeowners who have had the value of their homes drop and are also behind in their mortgage payments are less likely to face foreclosure. This is because the banks and lenders are less likely to recoup their losses through foreclosure proceedings.
Can a lender pursue other remedies?
Yes. Even if a bank will not pursue a foreclosure on an unsecured loan, a loan where the equity of the home is less than the amount left on the loan, it may pursue legal action in the form of a lawsuit seeking a money judgment from you. If the lender wins their lawsuit, it can take various steps to make sure you are still making payments on your mortgage. These methods can include everything from garnishing your wages to taking money directly out of your bank accounts. A money judgment could also let a lender place another lien on you home in the hopes that your home will gain in value in the future. However, the up side of these remedies is that you will likely be able to remain in your home.
Lawsuits normally take a long time to go to court. During this time, you may be able to raise money, negotiate with your lender, and perhaps even settle with your bank to avoid costly litigation. Many times banks are willing to settle for less than the amount left on your mortgage in order to avoid losing money by going through the foreclosure process.
The Last Resort
Even if your home mortgage is unsecured, you should only stop making payments as a last resort. Money judgments in favor of a lender can put a major strain on your credit score, which could make getting loans in the future more difficult - if not impossible. However, if suspending payments on a subsequent mortgage means you can continue payments on your first mortgage, then it is worth considering this option as a strategy for how to avoid foreclosure.
Is Your Loan Unsecured?
Many people become frustrated by to the process involved with determining whether a loan is unsecured or not. However, despite how complicated it may seem, finding out whether or not your loans are unsecured is an easy process. The hardest step is determining how much your home is worth.
You can easily hire a real estate broker to help you determine the value of your home. Then, you subtract the amount remaining on your first mortgage from this value. If you come out ahead (meaning that your home is worth more than the remaining debt on the first mortgage), your loan is still secured. However, if your home is worth less than the amount remaining on your mortgage, then your loan is unsecured and your lender will likely not pursue foreclosure if you stop making payments.
Here is an example to demonstrate this point. Assume that John's home is worth $300,000 and John still owes $250,000 on the first mortgage to purchase the home, and $150,000 on the second mortgage. In addition, when John ran into financial problems, he took out a home equity line of credit for $30,000. John is still having financial problems and wants to figure out his new financial strategy, including mortgage he should continue to pay off.
To figure out which loans of John's are secured and which are not, he needs to take the value of his home and subtract from that the amount he still owes on his first mortgage. The first mortgage is secured because John's home is worth more than the remaining debt on that mortgage. This means that the holder of the first mortgage may still pursue foreclosure proceedings because it would recoup all of its money.
However, the holder of the second mortgage would not likely pursue foreclosure proceedings. This lender would look at the value of the home, $300,000, subtract the remaining balance on the first mortgage, $250,000, and compare that to the remaining balance on the second mortgage. When that lender sees that there would only be $50,000 remaining after the sale of the home and compares that to the $150,000 remaining on the second mortgage, the lender will not be likely to pursue foreclosure. Because part of this loan is secured ($50,000), and part of it is not, ($100,000), this is an example of a partly secured loan.
The last loan, the home equity credit line, is an example of an unsecured loan. This is because there are two senior loan obligations that will exhaust the value of the home before the most junior loan is paid off. Thus, this creditor will also most likely opt out of foreclosure proceedings.
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