How to Avoid Foreclosure

Chances are when you bought your home with an adjustable rate mortgage, you planned to refinance into a more reasonable fixed-rate mortgage before your teaser rate reset. But now life has changed (not to mention interest rates and loan requirements), and it looks like you won't be able to refinance. What should you do to make sure you don't fall prey to foreclosure or succumb to a foreclosure-fix scam, which are happening more and more given what's going on?

First, meet with your lender five to six months before your mortgage is scheduled to reset if you are concerned about increased payments. Because an adjustable rate mortgage is based on one of several fluctuating indices, your lender cannot tell you exactly what your new payment will be on your reset date. However, they can compute what it would be if it reset on the date of your meeting, and they can show you a chart that displays a trend line for the index determining your payments. Be sure to take your original mortgage documents with you and know how much you can afford to pay each month. Most lenders want to work with you to find a way to help you stay in your home. They don’t want to foreclose on your property.

Meeting with a lender before a problem arises also gives you plenty of time to plan. If real estate in your area has lost considerable value and your lender is willing to give you a fixed-rate mortgage on a new and lower valuation -- you are fortunate. Breathe a deep sigh of relief and be thankful.

Unfortunately, some lenders will not be helpful. They will take advantage of your weak financial position and behave in a more predatory manner. Difficult as it may be to face this, the earlier you know, the more control you have of protecting your credit scores and fully recovering over the next year or two. Most important: Continue to make mortgage payments on time no matter how upset you are by a lender’s attitude.

In a situation where your lender will not work out a plan, you have three choices:

1. Cut your expenses. Stay in the house and, if possible, find ways to cut other expenses so you can continue to pay your mortgage on time after the increase. This strategy won't work, however, if you have already cut most of the fat out of your monthly spending and you don't have an emergency fund or savings.
2. Rent your house. In an area with a shortage of rental properties, you may be able to rent your house for more than the monthly reset mortgage payment. Contact a couple of local, established real estate firms with property management divisions to learn what rent you could expect. If they are familiar with your neighborhood and you accurately describe your property, they may be able to give you a figure over the phone, or they could schedule an agent to look at your house. In areas where rentals are in short supply and real estate is likely to increase in value, this can be the right solution. With a responsible renter, your house becomes an investment property that pays for itself while you downsize temporarily and take time to regroup financially.
3. Walk away. While this is a heart-wrenching decision for anyone, there are two options (see below) that provide the best protection for your future and ensure you aren't faced with foreclosure. In both cases, consulting a reputable real estate attorney for guidance is strongly advised. This attorney also can be helpful with lender negotiations. In addition, the U.S. Department of Housing and Urban Development offers advice and HUD-approved Housing Counselors on their Web site.
   • Sell. When a house is professionally staged, priced right and aggressively marketed, the National Association of Realtors believes it is possible to sell in any market. If your mortgage is greater than the current market value of your home, it’s a tougher situation. Your option is called a short sale. You sell your house for whatever the market will bear – less than you owe on your mortgage. Your lender agrees to write off the difference between the sales price and your mortgage debt. If your lender won’t work with you, you will not be able to sell the house.
   • Deed in lieu of foreclosure. In this strategy, you transfer the title of your home to your mortgage company in exchange for cancellation of your debt. Usually, you must try to sell your home at market value for 90 days before this option will be available. Starting early and completing this process before your mortgage resets will avoid the ongoing credit damage caused by multiple months of foreclosure.

With a real estate attorney on your side, you may be able to walk away from your house (either by selling or transferring title) without a hit to your credit ratings -- if your attorney effectively negotiates with the lender about how the lender reports to the credit bureaus. If not, you could take a severe credit blow, dropping your credit scores 200 points or more. If you pay every bill on time, keep your credit card spending below 10 percent of your account limits, and have at least four, but no more than seven, active lines of credit (car loans, credit cards, student loans, etc.), your credit scores should recover fully within a year. If your credit history includes recent negatives or you carry higher credit card balances, it will take longer to fully recover. With wise credit management, most people can build excellent credit scores within two years. The loss of a home can be emotionally devastating, but it need not mean credit death.