If you fall far enough past-due on your mortgage payments, your lender will declare the loan to be defaulted and will start a foreclosure. This usually happens when you fall more than three months past due. Once the lender makes this decision, they will no longer accept partial payments. If you cannot pay the entire past due amount in a lump sum, they will start a foreclosure. At that point, you have to make a decision. Do you keep the house, or do you let it go?
If you want to keep the house:
If you want to keep the home the best option is loan modification. The Financial Resource Center [dba Consumer Credit Counseling Service] in Arcata [822-8536] helps people with loan modifications for free. Most lenders will hold-off on a foreclosure while you are in an active loan modification. With a loan modification the lender will roll past-due payments back into the loan, drop the interest rate as low as 2% and re-amortize your loan over 30-years. This should drop your payment a lot. Your income must be 31% of the new payment. If you work carefully with the credit counseling service you should be able to determine whether you can craft an income disclosure that shows the correct percentage of income to payment.
Another option to allow you to keep a home is to file a Chapter 13 “payment plan” bankruptcy. A Chapter 13 Bankruptcy will stop a foreclosure. In a Chapter 13 Bankruptcy you must repay the past-due balance to the mortgage lender through a 5-year Chapter 13 Plan and resume your regular monthly mortgage payments directly to the lender. You have to be able to make the regular payment AND repay the mortgage arrears through the bankruptcy payment plan. Under some circumstances you may be able to use a Chapter 13 Plan to remove and eliminate a 2nd mortgage while you set up a payment plan to stop the 1st mortgage from foreclosing. In this kind of Chapter 13 Plan your other “unsecured” debts may be eliminated without needing to pay them anything.
A final option is to file a Chapter 7 Bankruptcy. The mortgage lender will have to stop the foreclosure once the bankruptcy case is filed. However, this protection is only temporary. Once the bankruptcy case is concluded [approximately three months] the lender will be able to resume foreclosure. The lender may be able to resume foreclosure sooner if they ask the Court for permission. Whereas the Chapter 7 Bankruptcy will only temporarily delay a foreclosure, it will eliminate your personal liability on mortgage loans so that after a foreclosure the lender will not be able to sue you for any remaining balance. Also, if you file a bankruptcy there is no “debt relief tax” for the portion of a mortgage loan that goes unpaid.
If you want to let the house go:
If you are OK with letting the house go and if there isn’t enough equity in the property for you to sell, allowing the property to go in a foreclosure is an option. If your property will be going through a foreclosure, you should be concerned about the amount of time you have before you must move out, whether you will owe money to the mortgage lender after they conclude the foreclosure, and whether there are any income tax consequences.
It takes about four months to complete a foreclosure. Note that it frequently takes much, much longer. Some lenders do not start a foreclosure until you are six months or more past due. You should consider staying in the house until the foreclosure is nearly complete. By staying in the house, you can make sure that the house remains in good repair and is kept safe for the new owners. This can also give you several months to save money to pay for the costs of relocation.
Under California law if your residence is lost in a foreclosure the foreclosing lender will not be able to sue you for any remaining unpaid balance. The situation is different for a 2nd mortgage or “junior” loan, such as an equity line of credit. If the 1st mortgage forecloses, the Junior lienholders often retain the right to sue you for any remaining unpaid balance owing. So, if you have a house with only a 1st mortgage and you let it go in foreclosure, you generally don’t need a bankruptcy. However, if there is an unpaid 2nd mortgage, you may need to eliminate the remaining unpaid debt in bankruptcy.
There can be income tax consequences after a foreclosure. Under some circumstances the amount of a mortgage loan that goes unpaid can be treated as “income” by the IRS and the SFTB for determining your income tax liability. There are exceptions to this “debt relief tax,” but you would have to discuss this with a CPA.
If you are willing to let the house go and if the property is under-water, one alternative to a foreclosure is a short-sale. If your home is worth less than what you owe a realtor may be able to find a buyer who will pay what it is worth and negotiate with the lenders to get the lenders to agree to accept the amount offered to release their liens against the property so the property can transfer to the buyer. The advantage of a short-sale is that it is mildly better on your credit. The downside is that the lender can sue you for the remaining unpaid balance unless you get a contract that protects you. As with a foreclosure, there may be income tax issues and you should consult with a CPA regarding the “debt relief tax” if you are considering a short-sale.