What is a Mortgage in Default? (The Definitive Guide)

Susan Kelly

Feb 01, 2022

A home mortgage is a complex financial agreement that can be difficult for consumers to truly understand. However, the consequences of defaulting on any mortgage are severe. What does it mean to default on a home loan?

Mortgage Defaults

A borrower defaults when he fails to meet the terms of his mortgage agreement. For example, if you fail to make your monthly payments for several months, not only will you continue to owe interest on that missed payment (so even if you catch up later, it's like starting all over), but it also means you haven't met the requirements of your loan. As such, defaulting on a mortgage is probably one of the worst financial moves anyone could ever make. While homeowners may think they can get away with keeping their house after missing some or all of their payments, this is simply not true. The lender has many options to protect itself and recoup any losses related to a defaulted mortgage.

A Matter of Equity

Even if you've fallen on hard times and have missed some of your mortgage payments, do not automatically assume you have defaulted on your loan. The F.H.A. defines a foreclosure as a process by which a property owner surrenders a mortgaged property to the lender because of an uncured default, usually due to the failure to make monthly mortgage payments. In foreclosure, you don't lose your home right away but rather have some time to try and save it from foreclosure. If the homeowner fails to perform a trial period plan or can't make any payments at all, the property will go up for foreclosure auction. However, there are other ways to lose your home through foreclosure even before you officially default on your mortgage.

For example, if your home is worth less than what you owe (i.e., if the total value of the loan is more than your home's value), you cannot refinance, otherwise known as a "short sale." For a short sale to occur, you must have enough equity in your home for the lender to agree to cancel the excess debt. In other words, if you owe $400,000 on a house that's only worth $300,000, even if you sell it for that much, there will still be a deficit of $100,000 between what you owe and what it's currently worth.

Know Your Options

While not necessarily considered defaulting on your mortgage loan per see, failing to pay property taxes or homeowners insurance can lead to foreclosure just as quickly. Not only does this mean not having the protection of firefighters in case your home catches fire (and paying hefty fines if it does), but these things are required by your lender. If you can't make these payments, you don't get to stay in the home--and it's better to figure that out before something happens rather than after.

If it turns out that foreclosure is imminent, know what your options are beforehand. In most cases, a short sale may be possible if your house value has fallen. Still, it will often result in a huge sum of debt remaining on your credit report for several years afterward. Even so, a negotiation with the bank may help ease the severity of this negative listing and reduce any further liability. You might also have some negotiating power if you have enough cash to pay off the difference between what the loan is for and how much the house is worth--known as a principal reduction.

If you're unsure if foreclosure is proper for you, several other options don't involve defaulting on your loan. You might qualify for a forbearance or deferral program, which would give you time to get caught up on payments and avoid any negative listings on your credit report.

Finally, keep in mind that while rent can be expensive, it's usually cheaper than the costs associated with the foreclosure. Realize that any liability you incur as a result of your home going into foreclosure will be reflected on your credit report for seven years or more and that it can affect not just your financial opportunities but all sorts of things from employment to medical care. Even if you don't think bankruptcy is right for you, the advice of an attorney might be a good idea before trying anything else.

There are many reasons why a homeowner may want to file for Chapter 13 bankruptcy protection, including:

  • You want to save your home from foreclosure.
  • You cannot afford the mortgage payments and other expenses like a car loan or credit cards.
  • The total value of your home is not enough to pay off the mortgage loan in full; it is worth less than what you owe (known as being "underwater").

If you plan on filing for bankruptcy, make sure that Chapter 13 is right for you. While the process itself can take five years to complete, this form of bankruptcy allows filers with a stable source of income to get rid of all sorts of unsecured debts such as medical bills and credit card balances. That way, they can start fresh after paying back their creditors an amount agreed upon through either negotiation or court proceedings. Filing for Chapter 7 bankruptcy, by contrast, requires that unsecured debts be paid off within three to five years and is typically only used by those whose income has dropped substantially and no longer have any way of paying their bills.

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