What happens when you can't pay your mortgage?

No homeowner who has a mortgage is ever completely safe from the possibility of foreclosure since few people are immune to financial setbacks such as a major illness, disability or loss of income. That’s not a happy thought, but it points out why it’s smart to understand what options are available if severe financial problems affect your ability to pay your mortgage.

Short sale transfers loss to the lender
One option for homeowners who’ve endured a true financial hardship may be a "short sale," in which the lender agrees to take a loss on the mortgage so the homeowner can sell the home prior to an impending foreclosure. A short sale, which requires the lender’s cooperation, relieves the homeowner of the burden, cost and emotional distress of a foreclosure.

To understand how a short sale works, suppose a homeowner obtained an interest-only loan of $150,000 to buy a $155,000 home that is now worth only $145,000. The costs to sell the home are expected to total $10,000. If the homeowner wasn’t able to pay the mortgage, the lender might agree to allow a short sale and cancel the $15,000 deficiency to avoid the costs and delays of foreclosure.

Deed-in-lieu offers quicker closure
Another option may be a "deed-in-lieu," in which the homeowner gives the home to the lender in a process that’s simpler, faster and less costly than a foreclosure. The cost savings is important because if the lender’s eventual sale of the home doesn’t result in enough money to pay off the mortgage and the costs of foreclosure, the lender typically can try to collect the deficient amount from the former homeowner.

A foreclosure can take as few as three or as many as 12 months to be finalized depending on the laws in the state where the home is located. Homeowners who want to "get it over with" and move on with their lives may prefer the deed-in-lieu to foreclosure. Again, the lender’s cooperation is a necessary element.

Homeowners may be dismayed to learn that a short-sale or deed-in-lieu can damage their credit just as surely as a foreclosure can and that the IRS may consider any debt that’s forgiven (i.e., canceled) by the lender to be taxable income. The tax consequences may be mitigated if the debt is eliminated in bankruptcy or the homeowner is insolvent.

Foreclosure is final out
If neither the short sale nor the deed-in-lieu is an option, the eventual outcome of a mortgage default typically is foreclosure, in which the lender takes over the ownership of the home.

Once the foreclosure process has started, the homeowner is not in a strong position to negotiate with the lender because missed payments, interest and penalties have already piled up. The borrower usually can be held financially responsible for the lender’s costs of the foreclosure as well.


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