How to Refinance a Defaulted Mortgage

Defaulting on a mortgage sounds disastrous, but while it is serious there are things you can do to recover. After all, default is not the same thing as foreclosure, which is losing your home. The key is to change course so that your default does not put you on track towards foreclosure, and sometimes the best way to make that course correction is to refinance a defaulted mortgage.

The goal of refinancing should be to alter your loan terms in a way that makes your financial obligations manageable. This might entail lowering the monthly payments over the life of the loan, or at least reducing them for long enough to get you over a temporary financial difficulty. Here are six things to keep in mind if you want to refinance a defaulted mortgage.

6 Things to Consider When Refinancing a Defaulted Mortgage

Stay in contact with your lender

People's instinct is often to hide from the lender when they can't make their payments, but this is the exact opposite of the right approach. Getting your loan out of default may well depend on the cooperation of that lender, so you need to make a good faith effort to solve the problem. Don't even wait for your lender to send you the first notice of default. As soon as you realize that you are not going to make a payment on time, get in touch with your lender to discuss your options. Also, if you want to refinance, by far your best shot is going to be with your current lender. Your default and the circumstances that led to it are likely to make you a credit risk other lenders would not want to take on. However, your current lender is already on the hook for that risk, and thus motivated to find a way to make things work out.

Pay what you can

This does not have to be an all-or-nothing approach. Making partial payments won't keep you out of default, but it can help reduce the extra interest expense accruing on the loan. Also, partial payments can shorten the time for which your loan is considered to be in default, and this can be valuable in putting off foreclosure.

Come up with a reasonable proposal

Don't expect miracles or charity from your lender. Think about how to construct a win-win proposal – something that makes your payments more manageable and yet gets the loan repaid in full eventually. In a best-case scenario, a drop in interest rates can reduce your payment, but if market rates have not dropped sufficiently, a good option can be to lengthen the time remaining on your loan. For example, if you are five years into a 30-year mortgage, refinancing to a fresh 30-year mortgage will spread your remaining balance out over 30 rather than 25 years, which should make the payments more affordable. If the problem is that you have encountered a temporary financial setback, you might also explore a structure that involves reduced payments for the near term in exchange for larger payments later in the loan term.

Include closing costs in the new loan amount

As you go through this process, don't forget that refinancing entails closing costs. Given your financial difficulties, your best option may be to finance those closing costs (i.e., add them to the new loan balance) so you can pay for them over time. This is more expensive in the long run than paying up front, but may be your only workable alternative.

Act with a sense of urgency

Although it can take years before default results in foreclosure, time is not on your side. Though most loans have a grace period of 10 to 15 days, after that you are going to start incurring late fees as long as you are in default. These will pile on top of the interest that will continue to accrue on your balance, as a result of which the amount you owe will be steadily growing while you are in default. If things get to the point where foreclosure procedures are initiated, you are also likely to incur legal expenses. In other words, any delay can turn a manageable financial problem into an insurmountable one.

Make your refinancing chance work

If you get the chance to refinance a defaulted mortgage, do everything you can to commit to a budget that will allow you to make your payments on time. Successful refinancing depends on the right interest rate conditions and the willingness of a lender – things you might not always be able to count on.

Foreclosure has long-lasting negative impacts. Not only do you lose your home, but your credit record will be damaged for years to come, and you will still face the expense of renting or otherwise paying for a place to live. So, look at all your options for preventing a default from leading to foreclosure, and being able to refinance a defaulted mortgage may well be your best option.

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