When it comes to loans, borrowers are not the only ones conducting due diligence. Lenders do so as well, especially since they need to take the higher risks. They will have to lend money to a stranger hoping that this person can pay back what they owe, including interest, on time throughout the life of the loan.
Due diligence matters so much that lenders usually ask for a long list of requirements that range from borrower’s income to credit scores. But sometimes, even doing this step religiously won’t guarantee that the borrower will not renege on the agreement.
If this happens, what can lenders do when people don’t pay mortgages? These are the options:
1. Foreclosures
The first path that lenders can choose is foreclosure. Foreclosure is the term used when someone takes back their property because of a serious loan default, usually defined as missing one or two mortgage payments in a row (although it can vary by state).
Foreclosure is a legal way to get out of an onerous mortgage. In most cases, the bank takes the title to the property and sells it at the auction, either in a public or private sale. If the account has negative equity (owe more than the house is worth), some states allow the homeowner to buy back the house at a new lower price without selling at foreclosure. But this right usually expires after 45 days or less.
Usually, a custodian/trustee, not the lender, mails the notice of trustee sale, telling the homeowner when and where the property will be sold publicly to repay the defaulted loan. Even though the borrower probably stopped making monthly payments, the law can still require a trustee sale notice regardless of whether the front already bears the For Sale sign.
When the borrower has already left the property, the lender can engage the services of a process server, whose job is to search the homeowner and ensure that they receive the notices and other foreclosure-related documents promptly. This way, they too can take advantage of due process.
2. Loan Modification
Although foreclosures remain a potent tool for lenders to recoup their money, many want to avoid them as much as possible. The process is lengthy, and each time they cannot collect from the borrower, they are losing money. Moreover, these situations can result in poor brand image.
Many lenders, too, would rather help mortgage borrowers pay than go through all the hassle. One of the alternatives is to offer a loan modification program.
Loan modifications are an option for homeowners who can’t pay their mortgage because of financial hardship. Several loan modification options are available, and one of the most popular is the interest-only payment.
In this arrangement, the principal amount owed on the home is not adjusted and remains at what it was when the homeowner first took out the mortgage before the default. Then, the borrower makes payments only to the interest for a certain period, which can last for three to five years.
This type of loan modification reduces the amount of money owed on the home and can result in smaller monthly payments or even an interest-free loan (depending on how much principal is reduced and for what term).
3. Short Sale
What is a short sale? One of the foreclosure alternatives, a short sale occurs when a homeowner sells their home for less than the amount due on the existing mortgage. In other words, one can sell their home for $50,000 (less than what is owed on the mortgage) and agree to repay the lender an additional $5,000 at a later date.
Why would someone want to do this? Short sales are attractive to homeowners because they allow them to avoid foreclosure proceedings while potentially saving thousands of dollars in penalties and legal fees.
When a homeowner cannot pay their mortgage, the lender can allow them to complete a short sale rather than foreclose on their home. As mentioned, lenders also don’t want to go through the more complicated and sometimes more heartbreaking foreclosure process.
While not all homeowners are eligible for this strategy, some lenders will accept it as an alternative to foreclosure so long as they believe that accepting the short sale offer is more financially sound than completing a foreclosure. Other times, banks will be forced by federal regulators, like those with Freddie Mac or Fannie Mae, to accept short sales to limit losses on bad loans.
When people feel that money is tight and might not afford to pay their mortgage on time, they sometimes think they have to make an all-or-nothing decision.
That’s not true. Options are available—always. These choices suit the lenders and the borrowers as both are actually on a lose-lose if they cannot decide on the best path to solving the problem.
