What Happens When You Default on a Mortgage?

Mortgage default occurs when a borrower fails to uphold the terms of their mortgage agreement, most commonly by not making required monthly payments. This breach of contract can also stem from neglecting to pay property taxes or allowing homeowner’s insurance to lapse.

Initial Stages of Mortgage Default

When a homeowner misses a mortgage payment, the loan does not immediately move into severe default. Most lenders provide a grace period, 10 to 15 days, during which a payment can still be made without incurring late fees. If the payment is not received within this timeframe, late fees are assessed, commonly around 4% to 5% of the overdue payment amount.

Following the grace period, mortgage servicers begin communication efforts to collect the overdue amount. This often involves phone calls and letters, informing the borrower of their delinquent status and accumulating charges. A missed payment becomes officially reported to credit bureaus once it is 30 days late, leading to a negative impact on the borrower’s credit score.

As payments continue to be missed, the servicer’s communications become more serious, often including a “Notice of Intent to Accelerate” or a “breach letter.” This notice informs the borrower that if the outstanding amount is not paid by a specified date, the lender may demand the entire loan balance immediately. Federal regulations require lenders to wait until a loan is at least 120 days delinquent before initiating formal foreclosure proceedings.

Exploring Options to Avoid Foreclosure

Before formal foreclosure proceedings commence, homeowners can explore several proactive measures to prevent the loss of their property. These options cater to different financial situations and require specific documentation to assess eligibility. Engaging with the mortgage servicer’s loss mitigation department is a first step in discussing these alternatives.

Forbearance

Forbearance allows a temporary reduction or suspension of mortgage payments. This is suitable for borrowers experiencing a short-term financial hardship, such as temporary job loss or a medical emergency. To request forbearance, homeowners must provide a hardship letter explaining their situation, along with recent financial statements like pay stubs or bank account records.

Repayment Plan

A repayment plan offers another avenue, enabling borrowers to catch up on missed payments over a defined period. This involves adding a portion of the overdue amount to their regular monthly payments until the loan is current. This option is suitable for those who have overcome a temporary hardship and can now afford slightly higher payments. Documentation for a repayment plan includes proof of current income, such as recent pay stubs, and a detailed budget outlining monthly expenses.

Loan Modification

For homeowners facing a long-term inability to make their existing mortgage payments, a loan modification can be considered. This involves negotiating new terms for the original mortgage, which might include a lower interest rate, an extended loan term, or a principal reduction, aiming to make payments more affordable. The application process for a loan modification requires documentation such as a formal application, recent pay stubs, bank statements, tax returns (e.g., IRS Form 4506-T), and a detailed hardship letter.

Short Sale

If retaining the home is not feasible, a short sale may be an option. In a short sale, the lender agrees to allow the property to be sold for less than the outstanding mortgage balance, accepting the proceeds as full or partial satisfaction of the debt. This is suitable when the property’s market value is less than the amount owed, and the homeowner needs to sell due to financial hardship. Required documentation includes a property valuation (e.g., appraisal or broker’s price opinion), proof of financial hardship, and a proposed listing agreement.

Deed-in-Lieu of Foreclosure

A deed-in-lieu of foreclosure allows the homeowner to voluntarily transfer the property’s title back to the lender in exchange for release from the mortgage obligation. This option is considered when other loss mitigation efforts have failed, and the homeowner wishes to avoid the negative credit impact of a foreclosure. Documentation includes proof of financial hardship, an assessment of the property’s condition, and a clear title to ensure no other liens exist. Both parties must agree to this arrangement, and the lender is not obligated to accept it.

The Foreclosure Process

If loss mitigation efforts are unsuccessful or not pursued, the mortgage servicer will initiate the formal foreclosure process to reclaim the property. This legal procedure follows specific steps, which can vary by state but follow a common progression.

Notice of Default (NOD)

The first step is the issuance of a Notice of Default (NOD). This formal document serves as a public record that the borrower has breached the terms of their mortgage agreement. It officially informs the borrower that the loan is in default and that foreclosure proceedings may begin if the default is not cured. This notice is delivered to the borrower via certified mail and may also be publicly recorded in the county where the property is located.

Notice of Sale (NOS)

Following the Notice of Default, if the default is not remedied, the lender will proceed with publishing a Notice of Sale (NOS). This notice announces the impending public auction of the property. The NOS specifies the date, time, and location of the foreclosure sale. It is published in local newspapers or posted in public places, as required by state law.

Foreclosure Sale

The next stage is the foreclosure sale, a public auction, sometimes referred to as a sheriff’s sale or trustee’s sale. These auctions are held at a designated public location, such as a county courthouse, or occasionally online. At the auction, the property is sold to the highest bidder, who must pay in cash or certified funds. The foreclosing lender makes an opening bid, known as a “credit bid,” which represents the amount owed on the mortgage plus any accumulated fees and costs. If no third party bids higher than the lender’s credit bid, the property reverts to the lender, becoming a bank-owned property.

Redemption Period

In some states, a redemption period may follow the foreclosure sale. This allows the former homeowner a specific timeframe to reclaim their property by paying the full amount owed, including the winning bid at the auction, plus any associated interest and costs. The duration of this redemption period varies by state, ranging from a few days to over a year. Whether it applies can depend on the type of foreclosure (judicial or non-judicial). While all states allow a borrower to redeem the property before the foreclosure sale by paying the full debt, post-sale redemption rights are not universal.

After the Foreclosure Sale

Once a property has been sold at a foreclosure auction, the former homeowner faces consequences. The legal transfer of ownership means the prior occupant must vacate the premises. The new owner, whether the foreclosing lender or a third-party buyer, will initiate procedures to gain possession of the property.

Eviction

The consequence after a foreclosure sale for the former homeowner is eviction. If the property is still occupied, the new owner must follow a legal eviction process to remove the former residents. This involves serving an eviction notice, such as a “Three-Day Notice to Quit,” followed by filing an unlawful detainer lawsuit in court if the occupants do not leave voluntarily. The court then issues an order, and if necessary, a sheriff or other law enforcement official will physically remove the occupants. The entire eviction process can take several weeks to a few months, depending on local court procedures and any defenses raised by the former homeowner.

Deficiency Judgment

Another financial outcome can be a deficiency judgment. If the property’s sale price at auction is less than the outstanding mortgage balance, the difference is known as a deficiency. In some states, lenders can pursue a personal judgment against the former homeowner for this remaining debt. Whether a lender can obtain a deficiency judgment depends on state law and the type of foreclosure, with some states having anti-deficiency laws that protect borrowers in certain situations. If granted, this judgment allows the lender to attempt collection through other means, such as wage garnishment or seizing other assets.

Credit Score Impact

Foreclosure also impacts the former homeowner’s credit score. A foreclosure causes a drop in credit scores, by 100 to 160 points, depending on the borrower’s credit standing before the event. This negative mark remains on credit reports for seven years from the date of the first missed payment that led to the foreclosure. While the impact lessens over time, it can make obtaining new credit, such as another mortgage or car loans and credit cards, more challenging and expensive in the years following the foreclosure.