Whether you’re considering the prospect of allowing your home to go into foreclosure or the bank has already started the process, there are several things you need to know about how this development will affect your family going forward.
How long does it take for a bank to foreclose on a home?
On average, people who lose a home to foreclosure have gone 14 months or more without making a mortgage payment at the time their home is repossessed. (Simons & Nelson, 2011) This is an average, however, and some banks may act much sooner.
What if my home is underwater?
Many people considering foreclosure do so because they are underwater in their mortgage, meaning they owe more than their house is worth. But you should understand that just because your home has been foreclosed upon does not mean that you’re suddenly off the hook for any debt payments.
“After the foreclosure action, borrowers often incorrectly believe that the first and second loans are extinguished because the property is sold,” says Scott Hawlet, a California-based attorney and expert on foreclosure-related legal and tax issues. “However, the second lender merely changes from a secured load to an unsecured loan. An unsecured lender may sue the borrower for the balance.” (Simons & Nelson, 2011)
As if to add insult to injury, lenders that do forgive the balance of a loan may saddle you with cancellation of debt income, which means whatever amount they forgive is reported as income you earned for tax purposes. If they forgave a $30,000 difference between what you owed and the amount your home sold for, then you could be liable for income taxes of $30,000 dollars. One possible silver lining is that at the time of writing this the Federal Mortgage Forgiveness Debt Relief Act exempts most homeowners from federal income taxation on forgiven mortgage debt. However, not all states have the same law, and the act itself must be renewed by Congress periodically or it expires.
Will home foreclosure keep me from buying a home again?
It certainly makes things harder, and it may also mean higher interest payments in your next loan, but having a home foreclosed upon does not deal a death blow to your dreams of home ownership. Lenders have become a little more forgiving of past failures in recent years, in no small part due to the fact that so many people defaulted during the housing crisis.
That said, under the best of circumstances you shouldn’t expect to be able to get another home loan for three or four years following a foreclosure. (ibid) If the foreclosure coincides with a bankruptcy filing, it may hurt your chances even further. Keep this is in mind when it comes to the expectations you give your children.
“The most important elements in obtaining financing after a foreclosure are the time frame that has passed since the foreclosure and having no derogatory credit after the foreclosure,” says Yvonne Hemmingsen, a mortgage broker in California. (ibid) It’s also important to work hard rebuilding your credit, especially when it comes to paying rent in a timely fashion. Any new lender is likely to seek documentation of at least 12-24 months of on-time payments.
Conventional (non-FHA) loans require a minimum credit score of at least 680, and the higher your credit score, the better your interest rates. FHA loans, which require only a 3.5% down payment, can be given with a 640 FICO credit score as soon as 3 years after a foreclosure. This, however, requires an extra process to get approval for an FHA loan. One other thing to be aware of: lenders will typically apply strict mortgage-to-income ratios to anyone who’s had a past foreclosure. So the cost of your new house generally can’t exceed 3-times your annual pre-tax income. (So if you make 60K/year, it needs to be $180,000 or under).
What to do if your home is going into foreclosure
- It’s generally a good idea to try and secure affordable rental housing for your family ahead of time. Keep in mind that it may be more difficult later, since even renters check a person’s credit score prior to renting. You don’t want to be scrambling at the last minute.
- Use this time to save money or pay down debt. If there’s one silver lining in all this, it’s that by the time your home is actually repossessed, you will have had the opportunity to be living in it rent-free for quite some time. Use this period wisely and build yourself a cushion.
- There are a couple of counseling organizations that specialize in helping people recover from home foreclosure, such as CredAbility.org or greenpath.com.