Alternatives to Foreclosure Flashcards
No discussion of alternatives to foreclosure would be complete without acknowledging the role and influence of the Consumer Finance Protection Bureau (CFPB).
The CFPB is a U.S. government agency whose mission is to ensure consumers are treated fairly by banks, lenders, and other financial companies. Those protections are needed more than ever by those facing the prospects of foreclosure.
120-Day Window
To that end, the CFPB has established timelines, guidelines, and rules to help the distressed homeowner avoid foreclosure or find alternatives to it.
Most of these take place within the 120 days that generally must pass before a lender can initiate foreclosure. (State law can influence the time between the start of the foreclosure process and the actual sale.)
So, what goes on during those 120 days? Well, that’s just what we’re going to talk about next!
CFPB and Loss Mitigation
There are multiple dates and activities of note that take place during the 120-day window that loan servicers usually have to let pass before taking action to foreclose on a borrower.
Just remember that all of them have a singular objective: Make borrowers aware of their circumstances and help them find a way to avoid foreclosure if that is their intent.
Servicer Duties: Contact & Notice
Typically, a loan servicer must make a good-faith effort to establish live contact (in person or over the phone) with a borrower within 36 days of that borrower’s deficiency. Following that, by day 45, a written notice of the delinquincy must go out to the borrower.
The purpose of the 45-day notice is to:
Provide the borrower with accurate information regarding their loan status
Encourage the borrower to establish communication with a representative of the loan servicing company to discuss loss mitigation
Make the borrower aware of HUD housing counselors that can help the borrower through this process
A person writing on a piece of paper with a pen.
Loss Mitigation: The Application
When the loan servicer sends a written notice of delinquency to the borrower, the clock starts ticking for the borrower to respond by filling out a loss mitigation application if they are so inclined.
To learn more about that, I’ll temporarily turn the reins over to the CFPB.
What happens after I complete an application to determine my options to avoid foreclosure?
It depends on your situation, but there are steps your servicer must usually take to evaluate your application.
Make sure your servicer receives your complete application more than 37 days before your scheduled foreclosure sale.
Warning: Under CFPB rules, if your servicer doesn’t receive your complete application more than 37 days before your foreclosure sale, your servicer doesn’t necessarily have to review your application. However, depending on what type of mortgage you have, your servicer might have to consider your application under other rules. For example, if you’re applying for relief under the National Mortgage Settlement, the process may give you additional protections.
Your servicer’s response
If your servicer receives your complete application more than 37 days before your scheduled foreclosure sale, you should hear back from your servicer in writing within 30 days. Your servicer may respond to your complete application in three ways:
Your servicer may offer you a loss mitigation option. It will also tell you how long you have to accept the offer. This may depend on how long before your scheduled foreclosure sale you completed your application.
Your servicer may deny you loss mitigation. If your servicer denies your application for a loan modification it has to tell you exactly why you were denied. If your servicer receives your complete application for loss mitigation at least 90 days before a scheduled foreclosure sale, you may also have a right to appeal if you were denied a loan modification.
Your servicer may ask for additional documentation or information. If your servicer does this, you should give the servicer what it asks for as soon as possible to make sure you have all possible foreclosure protections.
Loss Mitigation: The Ruling
The CFPB “120-day rule,” §1024.41, states that “nothing in §1024.41 imposes a duty on a servicer to provide any borrower with any specific loss mitigation option.” Nevertheless, given that lenders tend to lose money on foreclosures, they have a financial incentive to do so, and most of them have such programs in place. It’s usually not a question of if they have loss mitigation options to offer but whether or not the borrower qualifies.
What are some of the more popular loss mitigation options that lenders offer? That’s what we’ll talk about next.
CFPB: From Here to Foreclosure
When discussing the alternatives to foreclosure, it makes sense to split them out between those that allow the borrower to maintain possession of the property and those that involve relinquishing the property.
For reasons outlined earlier, before any steps towards foreclosure are taken, a lender will exhaust all alternatives for the continuation of the loan where possible.
A person holding a house in their hands.
Alternatives with Borrower Retaining Possession
Let’s take a look at some of the loss mitigation options lenders have on offer to help the borrower maintain possession of the property and stave off foreclosure.
Special Forbearance
This involves a temporary suspension of scheduled payments with the hopes that the borrower can use the time to make up the delinquency.
An assessment of what caused the default in the first place as well as the present and future prospects of loan payment will be considered before a lender would consider this option.
The lender works with the borrower by spreading out the past due amount over several future payments until the loan is brought current.
EXAMPLE
Pablo is a successful self-employed house painter. After falling from a tall ladder, he landed in the hospital for three months and racked up thousands of dollars of medical bills. Worse yet, Pablo had no income during that time.
As a result of this unforeseen and expensive event, Pablo fell behind on his mortgage loan. Prior to this, he had not missed a payment over the first seven years of the loan.
Taking into consideration Pablo’s previously spotless payment history and his full recovery, the lender determined that Pablo continued to be a good risk. Pablo gratefully accepted the lender’s offer of special forbearance that gave him the needed time to get his life and loan back on track.
Loan Modification
The current lender modifies or extends the existing term of the loan in order to offer a more achievable monthly payment. The downside to this for the borrower is that it increases the life of the loan and, consequently, raises the ultimate cost of the loan.
EXAMPLE
After Melinda’s boss at Acme Anchors informed her that, due to sinking revenue at the company, all employees would be taking a 25% cut in salary, she knew that her mortgage was no longer affordable.
Rather than fall behind on her payments, Melinda was proactive and called her lender to see what options they might have for her.
To Melinda’s great relief, the lender revised the terms of her loan by adding years to the back end. Although she would be paying more over the long run, the lower monthly payment allowed Melinda to stay in the loan and in the home she loves.
Refinance of Loan
In some instances, particularly if equity exists in the property, a refinance of the loan makes sense and is an option for the borrower. When this occurs, the delinquent payments are simply figured into the new loan balance and spread out over the life of the refinanced loan.
EXAMPLE
After Belinda’s boss at Acme Anchors informed her that, due to sinking revenue at the company, all employees would be taking a 25% cut in salary, she knew that her mortgage was no longer affordable.
Rather than fall behind on her payments, Belinda was proactive and called her lender to see what options they might have for her.
To Belinda’s dismay, the lender was unwilling to revise the terms of her original loan. Fortunately, Belinda had a great deal of equity in her home and had no trouble at all finding a new lender to refinance her mortgage, resulting in lower monthly payments she could afford.
Shortly thereafter, Belinda said “anchors aweigh” to her employer and started a rival company with her good friend Melinda. (Kinda beside the point of this example, but it makes for a happy ending, right?)
Partial Claim
For borrowers in an FHA loan who meet the eligibility requirements, a one-time, interest-free loan to cover the delinquent amount and reinstate the original mortgage loan is available.
This would be a completely separate loan and would need to be paid off once the mortgage loan is satisfied and/or the property is sold.
To be eligible for this loan from the FHA Insurance Fund, the borrower would need to be able to resume full monthly payments of the mortgage loan once reinstated.
Payment Forgiveness
A lender, on rare occasions, might forgive a missed payment if the borrower commits to making full, scheduled payments on the existing loan going forward.
Alternatives with Borrower Relinquishing Possession
If the lender and borrower are unable to find an acceptable alternative that allows the borrower to retain possession of the property, there are still a couple of alternatives to foreclosure to be considered:
Deed in lieu of foreclosure
Short sale
Even though the borrower has to give up the property, as they would with foreclosure, they might still find one of these alternatives to be preferable.
Because these alternatives are a little more complex and do occur in Arizona, we’ll use the next few screens to look at each one.
Two Categories of Alternatives
Often referred to as a friendly foreclosure or deed-in-lieu, a deed in lieu of foreclosure requires the agreement and cooperation of both lender and borrower.
These are the typical steps in a deed in lieu of foreclosure process:
Borrower deeds the property to the lender.
Lender cancels borrower’s debt.
Deed is conveyed and lien satisfaction is recorded.
Lender takes possession.
Pretty straightforward. Not too complicated. But there are some things for each party to think about. Let’s look at those now.
What the Borrower Needs to Think About
Spared both the personal embarrassment and the degree of credit hit that actual foreclosure can entail, the borrower may embrace deed in lieu of foreclosure as a way to make the best of a bad situation.
When Property Value < Outstanding Debt
If the value of the property is less than the outstanding debt, the prudent borrower should attempt to have the lender waive the right to a deficiency judgment (if the contract and/or state doesn’t already prohibit it) or negotiate it down to an amount the borrower can live with and get that commitment in writing.
In Arizona, lenders can, in some instances, pursue deficiency judgments. Therefore, the borrower would be well served to get the bank to waive their right to any deficiency judgment in writing in the deed in lieu of foreclosure agreement.
EXAMPLE
Bhavana’s mortgage fell into default. And it was obvious that she was not going to be able to reinstate or redeem her loan. Added to that, the balance on the loan significantly exceeded the value of her home.
Under these circumstances, Bhavana worked out a deed in lieu of foreclosure agreement with her lender on the condition that the agreement contained a deficiency judgment waiver.
When Property Value > Outstanding Debt
On the other hand, if the property value exceeds the loan debt, a deed in lieu of foreclosure agreement may not be the best idea. The borrower might be better served to sell the property, satisfy the loan with the proceeds, and pocket any profit.
EXAMPLE
Thadeus left his executive position with a large media company to focus full time on his special-interest podcast, “Darn Those Socks!” Unfortunately, Thadeus could never generate the kind of following needed to pull in the ad revenue he was hoping for.
Being slow to give up on his dream, Thadeus cut back on his expenses, including such things as participating in online sports betting and paying his mortgage.
It wasn’t long before the prospects of foreclosure darkened the door of his high-rise condo. Fortunately for Thadeus, his judgment in real estate exceeded his entrepreneurial instincts. The condo’s value well exceeded the remaining balance on his loan. So, in lieu of entering into an in lieu of foreclosure agreement with the lender, Thadeus simply sold the condo and paid off his mortgage.
Best of all, Thadeus still had enough left over to put down a security deposit and first and last month’s rent on an apartment in his mother’s basement.
The Tax Man Cometh
One more thing the borrower needs to be aware of: This process could be a tax event.
How so?
If the lender waives the opportunity to pursue a deficiency judgment, that is considered, for tax purposes, a forgiveness of debt.
If the debt forgiven is more than $600, the lender is required to report it to the IRS, who will be looking to see it reported as income by the borrower, unless certain exclusions apply.
But even if the borrower does not qualify for the IRS exclusions, they may still be rescued by the Mortgage Forgiveness Debt Relief Act if they meet its requirements and the act remains in effect.
What the Lender Needs to Think About
While the lender benefits from this alternative to foreclosure by avoiding the associated costs and delays, they might have to deal with junior liens that could come with conveyance of the title.
Depending on the number and severity of those junior loans, a lender might balk at deed in lieu of foreclosure or insist that they be resolved prior to the implementation of this alternative. The lender could also pursue an agreement with the junior lienholders to get them to release their liens on the property.
The truth of the matter is that the presence of junior lien holders will often derail any conversation about a deed in lieu of foreclosure — especially in states where lenders employ a relatively inexpensive, uncomplicated, nonjudicial foreclosure process.
Additionally, the lender should be aware that the courts tend to look out for the interests of the borrower if complaints about this process are ever raised. Given the financial and emotional distress of the borrower, the courts will look closely for any evidence that the lender is taking advantage of the borrower.
To address this possibility, most lenders will get an up-to-date appraisal on the property before even considering a deed in lieu of foreclosure agreement. By doing this, the lender can show that the market value of the property justified the deed in lieu of foreclosure process.
Imagine how it would look to the court if the value of the property exceeded the balance left on the loan? That would show that the lender did not act in the best interest of the borrower. Because, if the property value exceeded the balance on the loan, the borrower would be better served by selling the property and paying off the balance (as opposed to having the deed in lieu of foreclosure on their record).
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Deed in Lieu of Foreclosure
A short sale is similar to a deed in lieu of foreclosure in that it’s a mutually agreed-upon alternative to foreclosure.
With a short sale, however, a buyer is found who is willing to purchase the property for less than the outstanding loan balance, and the lender is willing to approve that sale.
Things to Think About
The same concerns regarding junior lienholders that were mentioned in our discussion of deed in lieu of foreclosure apply here, as well. Their cooperation will be required in order to complete a short sale.
And, as is the case with deed in lieu of foreclosure, the borrower should attempt to negotiate the issue of deficiency judgment and have the lender document that in writing prior to the short sale. (And, as with a deed in lieu of foreclosure, debt forgiveness can create a tax event for the borrower.)
Although initially slow to accept the concept of a sale price less than a debt amount, lenders have eventually come to see short sales as a way to cut their losses.
Fannie Mae & Freddie Mac Do Short Sales
Fannie Mae and Freddie Mac have short sale guidelines for their loans, as do most private lenders. A hardship letter indicating a borrower’s inability to fulfill the loan’s terms with supporting documentation is typical.
It Ain’t Over Until It’s Over
The short sale process can be disrupted in mid-course if the borrower were to declare bankruptcy or if the lender were to decide to pursue foreclosure. In other words, it’s not a done deal until the deal is done.
Short Sale
Until now, I’ve held off talking about bankruptcy as an alternative to foreclosure. Why? Because, unlike the other alternatives we’ve considered, it can involve either maintaining possession of your property or relinquishing it, depending on which form you choose to employ.
For Educational Purposes Only
Like you, I am not a lawyer, so what I share here is for your education only. If any clients you work with during your career were to seriously consider the option of bankruptcy, competent legal counsel is a must.
That said, here are the three forms of bankruptcy one might consider in lieu of foreclosure.
Chapter 13
Overall, this is the second-most common form of bankruptcy, but I am listing it first because it tends to be the first form considered when the intent of a homeowner is to retain possession of their property.
The primary purpose of Chapter 13 is to eliminate debt through the creation of a three-to-five-year repayment plan of debt owed to creditors — including the mortgagee.
Monthly payments are made to a court trustee who, then, distributes the funds to the creditors. At the end of the plan, all remaining debts are discharged.
Automatic Stay
Chapter 13 creates an automatic stay, which stops most collection actions and can save the borrower’s home from foreclosure. That said, the borrower will still be expected to make their current mortgage payments even as they fulfill their obligations to the repayment plan. Otherwise, the borrower can still be subject to possible future foreclosure proceedings.
To be clear, repayment of delinquent mortgage payments will be part of the overall debt repayment plan.
How It Works
Chapter 13 helps distressed homeowners who can pay some but not all of their obligations, particularly unsecured debt like credit cards and medical bills. It establishes a more manageable repayment plan of those debts while allowing the borrower to stay on top of their mortgage payments going forward.
This works best when the borrower can show a future income sufficient to meet all their financial obligations, meaning the repayment plan as well as the ongoing mortgage payments.
Chapter 7
Chapter 7, the most common form of bankruptcy, provides for the quick elimination of most unsecured debts through the surrender and liquidation of assets. The payment of creditors is funded by the liquidation of those assets.
It is possible for a borrower to keep their home via a Chapter 7 if they are or can get current quickly on their mortgage payment. If they cannot, then Chapter 13 may be the better option.
How It Works
If a homeowner can reduce or eliminate their unsecured debt load via funds obtained through the liquidation of assets, more of their income can be freed up to meet their mortgage payment obligations.
Chapter 11
While an individual might find their particular circumstances lend themselves to a Chapter 11 bankruptcy, it is a form of bankruptcy used more often by businesses than people. Its purpose is to reorganize and negotiate with creditors for more friendly repayment terms without having to sell the business’s assets.
Chapter 11 is not subject to restrictions based on income limits or debt levels as Chapter 13 is.
How It Works
Chapter 11 allows businesses to reorganize and restructure their debt without having to sell assets.
Bankruptcy
Can people who have experienced foreclosure ever hope to get financing again?
Yes. Yes, they can. But it won’t be easy.
Foreclosure, deed in lieu of foreclosure, short sales, and bankruptcy all make getting home financing a lot harder the second time around. Borrowers with any of these experiences on their profile will find their FICO credit score has taken a severe hit, a mark that will stay on their record for as long as seven years.
CAIVRS
The Credit Alert Verification Reporting System (CAIVRS) is the federal government’s database to track individuals who have defaulted on federal financial obligations.
Here’s what the folks at HUD have to say about it:
CAIVRS was developed by the Department of Housing and Urban Development in June 1987 as a shared database of defaulted federal debtors and enables processors of applications for federal credit benefit to identify individuals who are in default or have had claims paid on direct or guaranteed federal loans or are delinquent or other debts owed to federal agencies.
In 1989, the Office of Management and Budget set as a performance goal that certain program agencies and their authorized financial institutions should use CAIVRS to conduct prescreening to determine a loan applicant’s credit status with the federal government. The purpose of this methodology would enable the program agencies to prescreen their borrowers and to broaden the federal government’s base in determining an applicant’s creditworthiness. Some non-tangible factors are:
Verifying that loan applicants are not in default or delinquent on direct or guaranteed loans of participating federal programs.
Providing authorized users with a means to prescreen applicants for federal credit benefit, to avoid extending benefits to individuals who are
credit risks.
Demonstrating to the public the federal government’s commitment to collecting delinquent debt and the importance of meeting federal
obligations.
The government agencies reporting into CAIVRS include:
Department of Housing and Development (HUD)
Department of Veterans Affairs
Department of Education
Department of Agriculture
Small Business Administration
Department of Justice
Borrowers who have defaulted on loans from any one of these departments should expect to appear in the CAIVRS system. While a borrower does not have access to the CAIVRS database, lenders do. And they will check with CAIVRS before approving any loan.
What Lenders Want to See
While they undoubtedly prefer borrowers with a clean credit history, they will give borrowers with a foreclosure on their record a look as well.
What are they looking for?
Well, they want to see reasons to believe that the events surrounding the foreclosure are behind the borrower and are unlikely to be repeated.
A successful second-chance borrower profile will show:
Good credit prior to the foreclosure
Great credit subsequent to the foreclosure
Proof that the foreclosure was a one-time event
Indications of recovery and change needed to prevent reoccurrence of foreclosure
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Somebody’s Watching You
Okay, time to shift our focus a bit and look at what it takes for a borrower to get back into the game of homeownership after having experienced foreclosure. Let’s get a little more specific as to what a borrower can do to gain lender trust and talk about the wait times involved in getting financing.
Tick-Tock
Tick-tock, tick-tock… No, I’m not talking about that social media platform that all the kids are buzzing about these days. I’m referring to the waiting period that borrowers with a foreclosure in their past can expect to endure before someone will extend them a loan.
Here’s a chart showing the minimum post-foreclosure waiting periods that borrowers will face before being considered for these types of mortgage loans.
A chart showing the post-foreclosure loan waiting periods.
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Why the wait?
Well, lenders, being the risk-averse, number-crunching nerds that they are, will tell you that a past foreclosure makes you a statistically greater default risk on a future loan.
So, to combat that concern, lenders want to see a track record that proves that a borrower is back on their feet and behaving in a financially responsible way.
Even with an improved post-foreclosure financial history, borrowers can expect to see offers containing higher interest rates and larger down payment requirements. And some especially squeamish lenders might also want to see that the borrower has a cash reserve on hand that’s equivalent to a few month’s worth of mortgage payments.
Shortening the Delay
There are ways for borrowers with a past foreclosure to shorten their wait time, particularly if there are extenuating circumstances surrounding their default.
Keep Those Receipts
The borrower can’t just say, “there were extenuating circumstances” and expect lenders to go along with that. They will need documentation of it, including such things as:
Hospital bills and other evidence of medical emergency
News articles corroborating job layoffs, natural disasters, etc.
Police reports showing victimization of crime
Proof of the death of a primary household wage earner
The common and critical theme to whatever documentation the borrower has to show is that the event(s) were out of their control and not likely to repeat themselves.
A loan underwriter will review and evaluate a borrower’s documentation regarding the extenuating circumstances surrounding the foreclosure and make a judgment call. If they rule in favor of the borrower, a shortened timeframe for loan consideration is possible.
Here’s what our waiting-time table looks like when extenuating circumstances are considered.
A chart showing the post-foreclosure loan waiting periods with extenuating circumstances.
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Life After Deeds-in-Lieu and Short Sales
You may recall that I told you that the alternatives to foreclosure known as deed in lieu of foreclosure and short sale can lessen the degree of damage to a borrower’s credit rating relative to an actual foreclosure.
That is true and is reflected in the shorter wait times shown on this chart.
A chart showing the post-deed and short sale loan waiting periods with extenuating circumstances.
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Last Word
It should be noted that the waiting periods listed in the charts that I have shared are general guidelines from those named agencies in originating, insuring, or guaranteeing the loans. Individual lenders may have additional terms, restrictions, and timeframes they will want to use when dealing with borrowers with the credit histories we’ve been talking about.
But the good news is that there is such a thing as second chances for borrowers. There is homeowner life after foreclosure. It just may take a little extra effort to get there.
I’m sure, Anthony, you’re just the one to help borrowers like this to recapture their dreams.
Getting Back into the Homeowner Game
Chapter 3 was a veritable gold mine of precious information, Anthony. So, let’s do a quick review of some of the important terms, concepts, and principles you’ve learned along the way.
Key Terms
loan servicer
a company that manages or services loans, including collecting monthly mortgage payments; can be a separate entity from the company that originated the loan
Key Concepts & Principles
Here are the concepts and principles you’ll want to master from this chapter:
The 120-Day Rule
The Consumer Finance Protection Bureau (CFPB) has what is casually known as the “120-Day Rule” which refers to the window of time that must pass before a lender can usually initiate foreclosure.
The CFPB has established timelines, guidelines, and procedures to help the distressed homeowner avoid foreclosure or find alternatives to it. A primary part of these efforts centers around loss mitigation options offered by lenders to qualified borrowers.
Alternatives to Foreclosure
The two main categories of alternatives to foreclosure include those that allow the borrower to maintain possession of the property and those that involve relinquishing the property.
Retaining Possession
The alternatives to foreclosure that allow a borrower to retain possession of their home are those loss mitigation options a lender might offer to the borrower in default. They include:
Special forbearance
Loan modification
Refinance
Partial claim
Payment forgiveness
Relinquishing Possession
The alternatives to foreclosure that involve a borrower relinquishing possession of their home include:
Deed in lieu of foreclosure
Short sale
A chart showing the steps of a deed in lieu of foreclosure and the steps of a short sale.
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Bankruptcy
The three forms of bankruptcy one might consider in lieu of foreclosure include:
Chapter 13: A financial restructuring of debt through the creation of a three-to-five-year repayment plan of debt owed to creditors — including the mortgagee
Chapter 7: The quick elimination of most unsecured debts through the surrender and liquidation of assets
Chapter 11: A form of bankruptcy used more often by businesses than people to reorganize and negotiate with creditors for more friendly repayment terms without having to sell the business’s assets
Chapter Summary
