4 Negative Consequences of Defaulting on Your Mortgage
From: Aden Giang (Project Manager) & Elizabeth Low (Project Manager)
Owning a home and having the freedom to self-finance and live independently on one’s own property is a status of life many Americans seek. Yet according to the 2017 Prosperity Now Scorecard 36.8% [1]of Americans are in the financially red zone, meaning their liquid and available assets are not enough to keep themselves afloat for at least 3 months in the case of a personal emergency.
Since the Housing Crisis of 2008, the lender - borrower relationship which is standard for nearly all mortgages in America has been tarnished. This previously allowed borrowers to easily communicate lenders in the case of financial hardships, negotiating refinancing options like Loan Modifications, Repayment Plans and such under the protection of legislature like the California Homeowner’s Bill of Rights. As the housing market began to crash it became more and more costly for lenders to aid these troubled families. As a result, the customer service aspect has been lost leading to more foreclosures on families who simply haven't been taught to communicate properly with financial institutions.
Struggling homeowners are finding themselves increasingly discouraged to speak with lenders who consistently reject payments, asking for amounts due in financial jargon not easily digestible to the average homeowner. Yet in all relationships, communication is a must and falling behind on one’s mortgage is not a situation any family would like to be in. In California there is a strict 211-day timeline regarding foreclosure, beginning on one’s first missed mortgage payment. Families should not stress, and instead use it as a guideline to see what steps they may take to help remedy their financial situation. Being aware of this timeline is the first step to getting out of a payment ditch, and eventually being financially secure and responsible. Contrasting, there are several consequences if homeowners are not proactive in keeping their mortgages afloat, and one may find their situation spiraling out of control.
1. Credit Score
Mortgage delinquencies can have significant and long term impacts on a homeowner’s credit score. Missing a mortgage payment by more than 30 days often has a severe impact on one’s credit score. The higher the homeowner’s starting score, the bigger the impact a delinquency will have upon it. Just one late payment could knock off about 100 points off a 780 score, 80 points off a 720 score, or 70 points off a 680 score. Below is a table that outlines the impact of mortgage delinquencies on a homeowner’s credit score, calculated based on the homeowner’s starting credit score and the status of the delinquency.
After the effects of mortgage delinquency have impacted a homeowner’s credit score, scores will begin to recover sooner after a short sale or deed in lieu than after a foreclosure[2]. Even if the difference between moderate and severe delinquencies may be minimal, there may be significant differences in the time needed for scores to recover. This is because the foreclosure process typically takes much longer, according to Joanne Gaskin, director of FICO global scores. A short sale also allows for homeowners to apply for a conventional loan within four years. Following a foreclosure, however, a homeowner would typically be required to wait seven years to be eligible for another loan. In general, although one’s credit score could begin to improve sooner, scores could take up to 7-10 years to fully recover as a result of foreclosures and bankruptcy.
2. Compounding Debt & Late Fees
Late Payments - There are many behind-the-scenes dues that homeowners may miss when initially agreeing to terms with a lender. Rates initially seem reasonable on paper, yet after just one missed payment a title owner may find their dues increasing exponentially due to hidden agreements as well as compounding interest rather than a fixed as initially assumed. Lenders have in place what are known as grace periods, an acceptable time frame for submitting late payments. If a payment is not made until the end of said period, an assessment will be made to determine the size applicable late fees. This amount is stated in the promissory note, signed when the mortgage was originally accepted and taken out.[3]
Additionally, lenders may pass on these terms of the mortgage to the borrower further increasing their amounts due. These additional terms are all found within the original contract, stating what lenders and borrowers must pay under specific circumstances such as missed payments. Things like attorney fees, inspection charges, and costs associated with beginning and ending the foreclosure process may be applicable. This is typically 5% of the overdue payment of principal and interest mortgage4. If your late fee is 5% on a $2,000 mortgage payment, then you’d owe $100 after the grace period ends. It is important to make monthly payments on time to ensure one doesn’t incur unforeseen dues.
3. Legal Liability
Loan acceleration - A Promissory note is what lenders use as a documented “I Owe You” to clarify terms of a loan. One commonly misunderstood portion of the note, applicable in majority of employment and mortgage contracts is the Acceleration Clause. This clause may give the lender ability to request the entire reinstatement amount immediately, plus all interest that has accrued to date. For homeowners, this commonly happens when the borrower repeatedly misses payments and as a result would have to immediately owe the price of their property. As a reminder it is always advised to seek professional advice before signing any Long-Term binding contract.
Mortgage Liens - Mortgage liens work as a form of conditional ownership in which a homeowner may have title to the property, if dues and fees are kept up to date. Generally equal to the Payoff amount of the home, these must be upkept to keep ownership of the property. One way to immediately relieve the weight of a mortgage lien and its related notes is by selling a home “Subject-To” in which another person or institution may buy the property with all its legal obligations attached.
Deficiency Notes- Not applicable in California as protected by California CCP § 580b(3)[4]. In the event of a Short Sale, your lender could seek additional money based on the difference of net worth of the property minus sale price. If your lender is successful in obtaining a deficiency judgment, they could garnish your wages, freeze bank accounts, or place a lien on other owned properties. This benefits California homeowners because Short Sales not only provide a more immediate remedy to underwater borrower also meets a satisfactory common-ground with the lender.
4. Bankruptcy
Depending on the status of their mortgage delinquency, some homeowners may pursue the legal option of declaring bankruptcy to reduce the cost of defaulting on their mortgages. Homeowners facing mortgage delinquency typically view the relationship between bankruptcy and mortgage default as either complementary or substitutional. These two options are substitutes if homeowners pursue bankruptcy to save their homes, if they succeed in avoiding default. Alternately, these options are complementary if homeowners pursue bankruptcy to reduce the cost of defaulting on their mortgages, in which case they would do both or neither. According to the National Bureau of Economic Research, the bankruptcy/default relationship is complementary for most homeowners, as is the relationship between foreclosure and bankruptcy 6. However, homeowners who file for bankruptcy are much more likely to default, with 77% of homeowners with prime mortgages and 94% of homeowners with subprime mortgages default if they file for bankruptcy. These figures show that even if homeowners file for bankruptcy to save their homes, most of them do not succeed.
With our content, CORFund’s best practices improve financial literacy and seeks to educate the 52% of Americans facing financial hardships every day, helping them determine whether they are truly financially secure. From more obvious consequences like diminishing credit scores to lesser-known side effects like an acceleration clause, we hope that homeowners are proactive in financing their property and are aware of both the pros and cons of owning a home.
[1]
[2] https://www.sfgate.com/business/networth/article/How-mortgages-delinquencies-affect-credit-scores-2377081.php
[3] https://www.nolo.com/legal-encyclopedia/free-books/renters-rights-book/chapter3-6.html
[4] http://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=CCP§ionNum=580b