Homeowners have had a miserable couple of years, since the downturn in the economy pulled the rug out from under the equity in their homes.  Home prices dropped precipitously in many areas, just as many home loans began resetting to higher interest rates.  The squeeze has meant defaults, short sales, foreclosures and sometimes bankruptcy for many Americans.  If you are a homeowner in distress, or know someone who has been seriously affected by the slump in home prices, here is some important information:

What happens if I can’t afford my mortgage any more?

In most cases, your home loan agreement states that if you fail to make the required payments,  the lender will find you in default of your agreement to pay, and may begin action to take the property away from you through foreclosure.  With the large number of foreclosures happening right now,  it may take some time for the lender to complete the foreclosure process  -  but it can happen in as little as three or four months.

In California, foreclosure can be stopped by bringing all past due payments current at least five days before the scheduled foreclosure date.  Filing bankruptcy can delay foreclosure, and depending on the circumstances, may stop it.

Should I talk to my mortgage servicer and try to negotiate a better interest rate?

Absolutely !  If you think you may have trouble making your payments, or are already starting to fall behind, it may be possible to modify or restructure your loan now.  Here are some options:

  • Refinancing programs covering FHA, Fannie Mae and Freddie Mac loans are available for qualified homeowners whose mortgages are underwater, but who are current on payments.  It is possible to re-do the loan at a lower interest rate, and perhaps with better terms, so the borrower has a more secure and stable mortgage situation for the future.
  • The Home Affordable Modification Program (HAMP) is specifically designed for homeowners who have a documented financial hardship and meet strict requirements, including that  the home must be their principal residence, and the mortgage payment (including taxes, insurance, and HOA dues) must be more than 31% of their gross monthly income.  Homeowners may apply before or after filing bankruptcy.  Anyone considering this option should consult a bankruptcy attorney before applying for a HAMP loan modification.

What if I just sell my property for whatever it brings.  Can I walk away from my mortgage?

No, you can’t.  If you are considering selling your home for less than you owe on the mortgage, contact your lender or an experienced mortgage broker right away, and discuss the possibility of a short sale.  Most major lenders have signed onto the Home Affordable Foreclosure Alternative (HAFA) program to help homeowners avoid foreclosure.  Homeowners who qualify may get the lender’s approval to sell a home for less than the outstanding mortgage balance.  Short sales usually take a lot longer to process than normal real estate transactions, since the seller must negotiate with the buyer to reach a sales agreement, and the lender must review and approve it, as well.

If my house is foreclosed or I do a short sale, does my mortgage get wiped off the books?  Do I still owe the difference between the sale price and my loan?

Normally, in a foreclosure, your first mortgage is wiped out.  In most cases, the loan is secured only by the property itself, and not by any other assets you might have.  But, if you have a second mortgage or home equity line of credit (HELOC), the foreclosure does not affect those, and you will still owe the debt. 

In a short sale where the property is sold for less than the mortgage balance with the lender’s approval, you will no longer owe on any of your mortgages or a HELOC, even if the selling price was less than the amount of the mortgage loan. 

What about taxes?  Will I have to pay income taxes on any part of the loan than is forgiven in a refinancing, a short sale or foreclosure? 

Most homeowners fall under the provisions of the Mortgage Debt Relief Act of 2007 and the Mortgage Forgiveness Debt Relief Act of 2007.  Normally, debt which is forgiven or cancelled by a lender must be included as income on your tax return and is taxable.  In the first Act, qualified principal residence indebtedness and debts discharged through bankruptcy are excluded and not considered taxable income.  The second Act applies to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes.  There are limits to the amount of the loans, and other criteria may have to be met. 
You do have to report the amount of the forgiven debt on your income tax return, on Form 982.  Your lender will send you a Form 1099C showing the amount of the cancelled debt.

Which would be worse for my credit rating  -  foreclosure, short sale, or bankruptcy?

Foreclosure and bankruptcy are noted on your credit history for up to 10 years.  A short sale will definitely be noted if you missed or were delinquent on your mortgage payments prior to the sale.  If your general credit health is good and you are able to make all your other payments on time, a short sale may be a good option.

If a pattern of late payments and defaults has already damaged your credit score, it is possible that a bankruptcy would have less impact than a foreclosure.  Once debts are discharged in a bankruptcy, you no longer owe them, they show as a zero balance on your credit history, and they are no longer a drain on your income.  It is often possible to rebuild credit scores more rapidly after a bankruptcy because you have fewer debts overall, and more flexibility in how you spend your income.

This article is part of an ongoing series of articles pertaining to legal issues in the LGBT community. Previous articles can be viewed at www.heritagelegal.com.  This information is intended for general information purposes only, and is not intended to provide legal advice.  Christopher Heritage is an attorney in Palm Springs, and San Diego, CA, who focuses on LGBT estate planning, domestic partnerships, same-sex marriage, probate, trust administration, and consumer bankruptcy.  He welcomes questions and comments, and can be contacted at 760.325.2020, or by email: chris@heritagelegal.com