What Happens If I Default on My Mortgage?

When mortgage payments become unmanageable, understanding the implications of default is important for homeowners. This article explains what occurs when a mortgage goes into default, detailing typical lender responses, various pathways available to borrowers, and the foreclosure process with its lasting financial effects.

Understanding Mortgage Default

Mortgage default means a borrower failed to meet loan terms. This state usually occurs after a series of missed payments, often 90 to 120 days past due. The specific point of default is defined within the mortgage contract and promissory note.

Default can also result from failing to pay property taxes or homeowner’s insurance premiums. Violating loan covenants, such as transferring property ownership without lender approval or failing to maintain the property, can also trigger default.

Initial Lender Responses and Communication

After a missed mortgage payment, lenders initiate responses to prompt payment. A grace period, often 10 to 15 days, follows the due date before a payment is late and incurs penalties. Late fees, commonly 4% to 5% of the payment, are then applied to the account.

As delinquency continues, communication escalates, including automated phone calls, emails, and formal letters. These communications serve as notices of missed payments and reminders of the outstanding balance. The lender’s collections or loss mitigation department will attempt direct contact to discuss the situation and explore potential resolutions.

Options to Avoid Foreclosure

Many options exist for borrowers seeking to avoid foreclosure, each designed to address different financial situations.

Loan Modification

A loan modification involves altering the original terms of the mortgage. This might include reducing the interest rate, extending the loan term, or decreasing the principal balance. The goal is to make monthly payments more affordable and sustainable for the borrower.

Forbearance

Forbearance offers a temporary suspension or reduction of mortgage payments for a specified period, typically three to twelve months. This provides relief during temporary financial hardship like job loss or illness. Missed payments are then addressed through a lump sum, a repayment plan, or by adding them to the end of the loan term.

Repayment Plan

A repayment plan allows a borrower to catch up on past-due amounts. A portion of the arrears is added to regular monthly payments over a set period, often three to six months. This option suits borrowers who can now afford slightly higher payments to cure the default.

Short Sale

If retaining the home is not feasible, a short sale allows the borrower to sell the property for less than the outstanding mortgage balance, with lender approval. The lender accepts the sale proceeds as full or partial satisfaction of the debt, often forgiving the remaining balance. This process requires cooperation between the borrower, lender, and buyer.

Deed in Lieu of Foreclosure

A Deed in Lieu of Foreclosure is an alternative where the borrower voluntarily transfers property ownership back to the lender. This avoids the public record and fees associated with a foreclosure. It is considered when a borrower has no home equity and cannot sell it.

Refinancing

Refinancing involves taking out a new loan to pay off the existing one, potentially securing a lower interest rate or different terms. This option is often challenging to obtain when already in default. Lenders are hesitant to approve new loans for borrowers with a recent history of missed payments.

The Foreclosure Process

If mortgage default resolution efforts fail, foreclosure begins. This legal process varies based on whether it is judicial or non-judicial.

Judicial vs. Non-Judicial Foreclosure

Judicial foreclosure requires the lender to file a lawsuit in court to obtain a judgment to sell the property. This process typically takes longer, often several months to over a year.
Non-judicial foreclosure, permitted in many states, allows the lender to foreclose without court intervention if the mortgage contains a “power of sale” clause. This process is generally faster, often taking a few months from initial notice to sale.

Notice of Default (NOD)

The first formal step in many foreclosures is the issuance of a Notice of Default (NOD). This notice informs the borrower of default and specifies the amount needed to reinstate the loan. It is often filed with a county recorder’s office and marks the beginning of a reinstatement period, typically 30 to 90 days, to cure the default by paying overdue amounts plus fees.

Notice of Sale (NOS)

If the default is not cured after the reinstatement period, a Notice of Sale (NOS) is issued. This document specifies the date, time, and location of the public auction where the property will be sold. The NOS must be publicly posted and published in local newspapers for a statutory period, ranging from 20 to 90 days prior to the sale.

Foreclosure Sale

The foreclosure sale is typically a public auction where the property is sold to the highest bidder. Lenders often bid an amount equal to the outstanding loan balance, including fees, to reacquire the property if no other bids meet their minimum. If the property sells for less than the outstanding debt, the borrower may remain liable for a deficiency.

Eviction

After the foreclosure sale, the former homeowner typically receives an eviction notice to vacate the property. If they do not leave voluntarily, the new owner can obtain a court order for their removal. The eviction process can take several weeks, varying based on local laws.

Consequences of Foreclosure

Credit Score Impact

Foreclosure significantly impacts a borrower’s credit score. A foreclosure on a credit report can cause a substantial drop in a FICO score, often 100 points or more. This negative mark remains on credit reports for up to seven years.

Deficiency Judgments

If the foreclosure sale price is less than the outstanding mortgage balance, the lender may pursue a deficiency judgment against the borrower for the difference. For example, if a home sells for $200,000 but the outstanding loan was $250,000, the lender could seek a $50,000 judgment. Whether a deficiency judgment can be pursued varies by state law and foreclosure type.

Tax Implications

There can be tax implications from a foreclosure, especially if the lender forgives any debt. If a deficiency is waived, the forgiven amount may be considered taxable income by the IRS. The lender might issue a Form 1099-C, Cancellation of Debt. Consult a tax professional to understand these potential tax liabilities.

Future Lending and Housing

A foreclosure on a credit report makes it difficult to obtain a new mortgage for several years, often requiring a waiting period of three to seven years. Renting a new property can also be challenging, as landlords often review credit reports and may view a foreclosure as an indicator of financial instability.