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What to Know About Mortgage Default

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If you can’t make on-time payments on your home loan, you risk entering mortgage default — this occurs when you fail to meet the obligations listed in your mortgage contract for 30 days or more. Not only will your credit take a big hit, but you could ultimately lose your house to foreclosure.

Read up on ways to avoid foreclosure and learn the other negative effects of mortgage default below.

What does mortgage default mean?

When you sign a mortgage contract, you promise the lender that you’ll make timely payments on your home loan, as well as any associated property taxes, homeowners insurance and mortgage insurance premiums. Being in mortgage default means that you aren’t meeting some — or many — aspects of this promise.

Most lenders will grant you a small, 10- to 15-day grace period on a single missed payment. However, once a missed payment reaches 30 days past its due date, it gets reported to the credit bureaus and you will be considered “delinquent.” At any time after this point, if the balance due isn’t paid in full, the lender can issue a default notice and accelerate the debt or pursue foreclosure.

Late payments, default and foreclosure will harm your credit score — and the later the payments, the steeper the penalty. Thankfully, if you find an incorrect late payment or default recorded on your credit report, you can take action to dispute it and have the credit bureau remove it. Otherwise, late payments will only stop affecting your credit and disappear from your report after seven years.

Situations that can lead to a loan default

We know the loan default definition, but what leads to default? Typically, homeowners in default are facing financial hardships, such as:

  • Divorce
  • Job loss
  • Medical bills
  • Death or illness of a primary income earner
  • Reduction in income
  • Financial emergencies like an unexpected home or car repair
  • Increasing credit card or other loan debt
  • Increasing mortgage payments

Some mortgages, called adjustable-rate mortgages (ARMs), have rates that can change after an initial fixed period. When this happens, there’s the potential for “payment shock” — a homeowner’s inability to cope with the sharp spikes in their PITI payment that result from adjustable rate changes.

In some cases, homeowners enter default for breaching parts of the mortgage contract that have nothing to do with the mortgage payments, like:

  • Failure to pay homeowners insurance premiums
  • Failure to pay property taxes
  • Transferring a title without the permission of the lender
  • Severely harming the mortgaged property, including its natural resources
  • Conducting illegal activities on the property

In any of these cases, the lender can initiate the foreclosure process or — if there’s an acceleration clause in the contract — call the entire debt due immediately.

What are “walkaways” and underwater homes?

Another scenario that can lead to mortgage default is known as a “walkway,” and occurs because a house goes underwater — this means that the value’s fallen so far that it’s worth less than what’s owed on the mortgage. In that situation, a homeowner can decide to simply walk away from the house and the loan as a way to cut their losses. However, this is a fairly rare form of default associated with extreme downturns in the market, like the housing crisis that accompanied a global financial crisis in 2007 and 2008. 

Underwater homes don’t have to be, but often are, defaulted on. Severely underwater homes  — defined by researchers at ATTOM Data Solutions as houses whose mortgage is more than 25% higher than their current market value — account for about 3% of all mortgaged homes in the U.S.

5 ways to avoid foreclosure after a mortgage default

If you’re struggling to make mortgage payments — even if you haven’t missed any yet — your first step should be to contact your lender. Give them insight into the hardships you’re facing and you might be surprised at how willing they are to work with you.

Here are some common options your lender might offer:

  • Refinance.With a refinance, you get a new mortgage with terms that are a better fit for your financial situation. The new mortgage pays off the old mortgage. You can even refinance if you’re underwater with special programs through Fannie Mae, Freddie Mac and government-backed lenders.
  • Loan modification.A loan modification is a change to the original terms of your mortgage. Your lender might agree to extend the term length or reduce the interest rate to make your payments more affordable.
  • Forbearance.A mortgage forbearance is when your lender agrees to suspend or reduce your payments temporarily.
  • Deed-in-lieu of foreclosure.A deed-in-lieu of foreclosure allows you to voluntarily transfer your property to your lender and, in exchange, the lender lets you out of the mortgage.
  • Short sale.With a short sale, you work with your lender to sell your home for less than the full amount you owe — however, you may have to pay taxes on the forgiven mortgage balance.

If you’re not able to utilize any of these options and are headed toward foreclosure, lenders are required to offer you loss mitigation options during the pre-foreclosure period (the 120-day period after your first missed payment). You may also want to contact a housing counselor. The federal government provides free foreclosure-prevention counseling through its housing counseling program.

What are the consequences of foreclosure?

If you’re in mortgage default and aren’t able to come to an agreement with your lender, the next step is foreclosure. This will allow the lender to repossess your house and sell it in order to recoup their money. Foreclosure has many financial and personal consequences worth considering.

You’ll lose your home

The most important foreclosure and loan default consequences are personal. The financial and emotional stress of losing a home has a lasting impact on a family’s well-being. It’s also much harder to qualify for another mortgage or rent a home with a foreclosure on your credit, which can lead to even more stress and hardship.

Your credit will take a hit

Credit scores can drop by 150 points or more after a foreclosure, according to LendingTree research. And while scores typically rise by about 10 points per year after a foreclosure, you will have to wait seven years for the foreclosure to stop appearing on your credit report.

You may have to file for bankruptcy

Some homeowners delay or stop the foreclosure process by filing for bankruptcy. Chapter 13 bankruptcies stay on your credit report for seven years, while Chapter 7 bankruptcies stay on your credit report for 10 years.

Your lender might sue you

When a lender forecloses on your home, it sells it to pay off your mortgage balance. If the house doesn’t sell for enough to cover what you owe, your lender could sue you for the remaining balance.

You’ll have to wait several years to buy another home

It can take two to seven years to qualify for another mortgage after a foreclosure. Foreclosures show up on CAIVRS, a government database that lenders check to ensure you haven’t defaulted on previous federal debt.

The waiting period will vary depending on the mortgage type:

  • Conventional loan: You’ll have to wait seven years, but it can be as little as three if there were extenuating circumstances.
  • FHA loan or USDA loan: Mortgages backed by the Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) require a wait time of at least three years, although both allow for a shorter wait if there were extenuating circumstances.
  • VA loan: Loans guaranteed by the U.S. Department of Veterans Affairs (VA) require a two-year wait, although exceptions can be made for extenuating circumstances.
 

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