How to Refinance a Defaulted Mortgage
Falling behind on your mortgage payments is a stressful and sometimes complicated situation, but there is help for getting back on track and avoiding the worst-case scenario: foreclosure. Job loss, an unexpected expense, a drop in equity in your home and disasters such as hurricanes or wildfires are common reasons for mortgage delinquencies and defaults. The good news? Delinquency rates are the lowest they’ve been in a decade thanks to a strengthening economy and higher employment rates.
Even better: Foreclosure is rare. “Serious delinquency” rates — mortgages that are 90 days or more past due — fell to 1.03% in May, according to Fannie Mae. The nationwide foreclosure rate in March had returned to pre-recession levels of 0.6%.
In this article, we’ll discuss what it means when you’ve defaulted on your mortgage, how to refinance a defaulted mortgage and the differences between delinquency, default and foreclosure.
Is it possible to refinance a defaulted mortgage?
Some banks and mortgage lenders will let you refinance your mortgage if you’re in default. If you’re facing financial difficulties, you should start with your lender. In some cases, your lender may give you options to help streamline your refinance. However, you might not get the best terms or interest rates since you’re in default, but it is an option if your lender is willing to refinance and roll your past due payments into your new loan.
You defaulted on your mortgage, now what?
If you’ve received a notice of default, you must take action and get in contact with your bank or lender immediately, if you haven’t done so already. One of the worst things you can do is to avoid phone calls and notices about your missed payments. Arrange a meeting or schedule a phone call with your bank’s representative, and ensure you keep the appointment. In some cases, you may need to call the servicer of your mortgage if the original bank sold your loan on the secondary market.
If you have a history of paying your mortgage on time and you recently started missing payments, your lender may be cooperative and help you find a solution. For example, your bank may work with you to modify your existing loan, and some lenders have their own modification programs.
Modification vs. refinance. In industry terms, a loan modification occurs when a bank or lender permanently restructures your existing mortgage to give you a lower monthly payment using a lower interest rate or a reduction in your principal balance. However, don’t confuse a loan modification with refinancing your mortgage. When you refinance your mortgage, you’ll pay closing costs and fees for a new loan while modifying your loan with a lender generally doesn’t involve additional closing costs.
“I talk to a lot of people who think loan modifications and refinancing are the same thing,” said Rudy Benitez, a senior mortgage consultant with AnnieMac Mortgage, based in Casa Grande, Ariz. “Not understanding the difference can really hurt people who defaulted on their mortgage and are looking for ways to get their mortgage current.”
Benitez explains that when you’re refinancing your mortgage, you’re replacing your existing home loan with a new home loan that has a new interest rate and new loan terms. A loan modification changes the terms of the current loan but doesn’t replace it.
Your bank or servicer, for example, could change the terms of your current mortgage to 40 years if you currently have a 30-year, fixed-interest rate loan, which reduces your total monthly payment obligation. Although it will take longer to pay off your mortgage, you will get out of default status, avoid foreclosure and keep your home.
A modification may also include adjusting your interest rate to an index of modification interest rates established by Freddie Mac. The goal here is to get you close to current market interest rates (if you haven’t been able to refinance into a lower rate) and get you back on the right financial track. Fannie Mae and Freddie Mac, the two government-sponsored enterprises that buy loans from lenders and package them into mortgage-backed securities, have their own modification programs that we’ll discuss later.
Financial hardships. If you’ve missed your payments because of a hardship, such as a job loss or a medical emergency, your lender or servicer may approve you for a loan modification. For example, Michigan-based Flagstar Bank, one of the top 10 mortgage lenders in the United States, offers several options for its customers who are facing a financial hardship. However, you’ll need to describe your hardship truthfully and detail exactly what happened. Most lenders will require you to complete a hardship letter. Here are some common hardships (keep in mind that a hardship doesn’t guarantee you will qualify for a modification):
- Loss of employment or cutback in hours. Be prepared to provide proof you or your spouse lost your job, and gather all your pay stubs showing any declines in household income due to a reduction in hours.
- Illness or injury. Major medical emergencies such as a heart attack, cancer, stroke, an Alzheimer’s diagnosis, a sudden death in the family or progressive diabetes symptoms qualify as a hardship.
- Separation or divorce. A separation or divorce financially devastates most people. Therefore, many lenders will work with you if you’re facing an imminent divorce.
- Disasters. Auto accidents, fire, flood or any other act of God qualifies as a hardship.
- Payment shock. If you have an adjustable-rate mortgage (ARM), there’s a chance your monthly payment will rise significantly if your interest rate rises in the first few years of your loan term. If your payment does rise, and you didn’t realize it would rise as much as it did, it is known as payment shock. However, you must prove to your lender that you did not reasonably foresee the significant increase in your mortgage payments.
Other steps you can take to get your mortgage out of default
Forbearance. A forbearance temporarily suspends or reduces your monthly mortgage obligation if you’re facing short-term financial difficulties. To qualify for a forbearance, you will need to explain to your lender why you can’t make your payments. If you’re approved, you and your lender will discuss the length of the forbearance period and the repayment terms.
If you have a Federal Housing Administration or Veterans Affairs-backed mortgage, you might qualify for a special forbearance if you’ve recently lost your job and you can no longer make your mortgage payments. If you can verify a loss of income or full unemployment, the U.S. Department of Housing and Urban Development’s (HUD) loss mitigation policy allows the mortgage servicer to “suspend or reduce your monthly payment obligations for up to 12 months” if you’re 61 days or more past due.
The forbearance is a written agreement between you and your lender, and the FHA doesn’t administer the forbearance. The FHA’s role is to provide guidance and instructions to your lender or mortgage servicer in the event you’ve defaulted or are in danger of defaulting.
Short sale. If you’ve defaulted on your mortgage and you’re facing imminent foreclosure proceedings, a short sale could help you reduce or eliminate your loan debt. A short sale is the process of selling your home for less than what you owe. Keep in mind that a short sale doesn’t help you get out of default and you don’t keep your home. It is entirely up to your lender to approve you for a short sale.
Deed-in-lieu of foreclosure (mortgage release). If your bank rejects your request for a short sale, or you just can’t afford your house anymore, you can request a deed-in-lieu of foreclosure (mortgage release) from your bank. The process lets you turn all the ownership interests you have in your home to your bank, and in return, your lender releases you from any debt that is remaining on your mortgage. You’ll work directly with your bank, and you must complete an eligibility process. Keep in mind there is no guarantee your lender will approve a mortgage release, and the process varies by lender and your state.
For example, some states require you to pay the difference if you owe more than the current value of your home (often referred to as an “underwater mortgage”). If this is the case, you’ll have to ask your lender to release you from the deficiency.
Are you delinquent on your payments, or are you in default?
Delinquency and default are terms used to describe a certain level or degree of missed payments. In the mortgage industry, it is critical to understand the difference between the two. Delinquency typically describes late payments or missing one or two consecutive payments. A mortgage is in default when you fail to make a series of payments and is generally a consequence of delinquent payments.
In most cases, your lender or servicer will send you a notice of default. Your mortgage note or deed of trust will contain language that states they must send you a notice that your loan is in default. Additionally, your note may contain an acceleration clause that lets your lender demand immediate payment of the principal balance if your mortgage is in default. However, mortgage laws vary by state, and lenders must follow very specific guidelines before they can change the locks on your house.
How to refinance a defaulted mortgage
“If you’re in default, you’ll have a difficult time refinancing, that is the nature of the lending business,” Benitez said. “However, it is not impossible, especially if you can prove you have a legitimate financial hardship, or you have a significant amount of equity built up in your home.”
Benitez said that your best course of action is to try and make at least one of your payments before you try to refinance. This will show lenders you’re making an honest attempt to get your mortgage out of default. If you can’t make a payment, you could apply for a home equity loan or a home equity line of credit (HELOC) if you do have a large amount of equity in your home.
However, there is a good chance that your missed payments are now on your credit report and have adversely impacted your credit score. This will hurt your chances at an approval, and if a lender does approve you, you will pay a much higher interest rate and pay more fees than a borrower with good credit. You might also only qualify for a HELOC or home equity loan with a very low loan-to-value ratio (LTV), which is the amount of money you can borrow against the appraised value of your home.
Fannie Mae and Freddie Mac Flex Modification
Fannie Mae and Freddie Mac, the two government-sponsored enterprises that we discussed earlier, offer a modification program called Flex Modification, which is designed to help you if you’re behind on your payments or you’re facing imminent default. The program can help you reduce your monthly mortgage payment by up to 20% by lowering your interest rate or reducing the principal balance of your Fannie or Freddie home loan. The program also adds your defaulted payments into the new principal balance of your loan. If you make timely payments during an initial trial period, your mortgage lender will register your home loan as current.
|Flex Modification basic eligibility requirements|
*Unemployment benefits cannot be considered as a source of income.
As a reminder, a loan modification only changes the terms of your current mortgage and does not replace the home loan. The Home Affordable Modification Program, which was developed by the federal government in response to the housing crisis of 2008, expired in December 2016. Since the program expired and many borrowers are still struggling today from the effects of the recession, the flex modification programs were formed to replace HAMP.
Default vs. foreclosure
With so much paperwork and so many legal terms involved in the mortgage process, it can be difficult to keep track of the language you need to understand the most. Since we’re talking about refinancing a defaulted mortgage and what to do if you’re in default, you should know the difference between defaulting on your mortgage and foreclosure.
The bottom line is a mortgage default occurs when you miss a series of monthly payments. The lender will then send out notices or other forms of communication demanding payment. If you fail to remedy the missed payments with your lender, foreclosure proceedings will start. When lenders do foreclose on your home, they take possession of your home and try to sell it at a public auction. Although the foreclosure process is different in every state, most lenders will start foreclosure proceedings about 90 days after you missed your first payment.
Every state in the U.S. has their own foreclosure process. Some states don’t require lenders to take you to court to foreclose on your home. Known as a nonjudicial foreclosure, these states often have a clause in the deed of trust that gives the lender the “power of sale.” This basically means lenders can sell your home at auction once you’ve defaulted on your payments. However, your lender must have established a reasonable “waiting period” before they can foreclose. Judicial foreclosures require lenders to get a court order before they can foreclose and sell your home at auction.
The last word
Defaulting on your mortgage isn’t something you should take lightly. If you have defaulted, or know you’re going to miss your payments, you should contact your lender immediately. When you talk to your lender, make sure you ask about a possible forbearance, loan modification or refinance if you have the equity in your home. If you have an FHA-insured loan and you lost your job, talk to your lender about a special forbearance for unemployed borrowers. Do recognize that defaulting on your mortgage should be a last resort if you can’t make your payments. You’ll be intentionally hurting yourself and your financial future if you fail to take prompt action.