While a mortgage can provide you with a great opportunity to become a homeowner, it also brings a long term financial commitment. If you fall behind on your repayments you may enter default. While this can be a stressful situation to be in, knowing what a mortgage default is, how it happens and what you can do can help you make the best choices.
Mortgage defaults generally don’t happen after missing just one payment. Most lenders will send reminders, charge late fees and give you time to get back on track. If you ignore the issue you may face some serious consequences.
What is a Mortgage Default?
A mortgage default happens when you fail to meet the repayment terms of your home loan. This most commonly happens when you miss paying your monthly mortgage payments. However, it could also happen if you fail to pay your property taxes, home insurance or other charges.
The definition can vary dependant upon your loan agreement and local legislation. Generally speaking, you’ll be classed as being in arrears once you’ve missed a payment. However, your lender may not class the loan as being in default until you’ve fallen behind for a certain length of time.
Delinquency – Usually means your payment is late or overdue.
Default – Usually means you’re having more serious issues meeting the terms of your loan.
Foreclosure – If you enter default your lender may legally take back ownership of the property.
While related, there are different stages. By acting quickly you may be able to avoid entering a mortgage default.
Common Reasons For Entering Default
One of the most common reasons for falling into default is due to financial issues. Losing your job, reducing your hours, unexpected medical bills, divorce or a major family issue can all cause problems with your household budget.
Your mortgage may enter default due to:
Increased interest rates on an adjustable rate mortgage.
Increased property taxes or home insurance.
Too much credit card or personal loan debt.
Poor financial planning.
Reduced property value.
Unexpected maintenance bill.
Changes to your income.
Borrower passing away or becoming seriously ill.
Sometimes default can happen due to a number of small issues adding up. Increased utility bills, increased insurance and less overtime can cause the monthly repayment to become unmanageable.
Whatever the reason, the sooner you contact your lender the better. If you wait too long you may have fewer options.
What Happens If You Miss A Payment?
Every lender will have different processes for dealing with a mortgage default, however there are usually a few steps involved.
1. Payment becomes overdue.
Generally, if you don’t make your payment on time it will be classed as late. Many mortgages will have a grace period (usually 10-15 days) before charging late fees. This will depend on your loan terms.
You may not enter foreclosure straight away but could face financial issues. If your payment is significantly overdue your lender may report you to the credit agencies which could reduce your credit rating.
2. Late fees and reminders.
If you don’t pay your account up to date your lender may send you reminders via post, phone or official letters. These can tell you how much you need to pay to bring your account up to date and warn you that legal action may be taken.
Don’t ignore these letters as they often have deadlines and information on how to get help.
3. Official default notice.
After missing a certain number of payments your lender may send you an official default notice. This may give you a short period of time to sort your account, apply for loss mitigation or dispute any errors.
How long this takes can vary massively. Some lenders will send official notices after 3 missed payments. Others may wait longer. Local legislation regarding foreclosure may also affect this.
4. Foreclosure.
If you don’t solve your default your lender may begin the foreclosure process. This can be done via the courts or administratively, depending on local legislation.
If you enter foreclosure you may lose ownership of your property. In some cases, your lender may try to claim the shortfall if they sell your property for less than you owe them. This can vary depending on your local rules.
Impact On Your Credit
Entering mortgage default can greatly affect your credit. Payment history is one of the most important factors when calculating credit scores. This can cause your credit score to drop dramatically.
This can affect you for many years. Having a poor credit profile can make it harder to:
Get another mortgage.
Rent a property.
Get a personal loan.
Get a competitive interest rate.
Get approved for certain insurances.
Pass some credit checks for jobs.
The sooner you act the better. Getting your account up to date, coming to an alternative arrangement or completing a loss mitigation plan may be less damaging than entering mortgage default.
Ways To Avoid Foreclosure
If you’re struggling to keep up with your payments you should speak directly to your lender/mortgage servicer. Many lenders will have a department to help those in financial difficulty.
Options include:
Forbearance
Forbearance will reduce or pause your payments. This can help if you’re facing unemployment, illness or another financial issue. However, you’ll usually have to pay the missed payments at a later date either as a lump sum, repayment plan or loan modification.
This is not forgiveness of your debt. You should know when you’ll have to start paying and how much you’ll have to pay.
Repayment plan
A repayment plan will allow you to spread your arrears over a few months. This could be a good option if your financial difficulties were temporary and you can afford to pay a higher monthly payment.
Loan Modification
A loan modification will change some aspects of your mortgage. Your lender may increase the length of your loan, reduce the interest rate, add the missed payments onto your balance or make other changes to create a more affordable payment.
You’ll usually need to provide evidence of your income, outgoings, assets, debts and reason for your financial difficulty.
Refinance
Refinancing will replace your mortgage with a new loan. If you have enough income, credit and equity this could reduce your interest rate or monthly payments. However, if you’re already in a severe default it may be difficult to qualify.
Sell your property
If you have enough equity in your property you may be able to sell it. The sooner you do this the more control you’ll have and may avoid entering foreclosure.
Short sale
If your property is worth less than your mortgage your lender may allow you to complete a short sale. This means selling your property for less than you owe them. Ask if they’ll forgive the balance or chase it. You should also be aware of any tax implications.
Deed in lieu of foreclosure
This means you can hand over ownership of your property to your lender. It may be a simpler process than entering foreclosure. However, it won’t be suitable for everyone. You should look at any junior liens, tax issues or other legal issues first.
What To Do If You’re At Risk Of Default
Act as soon as possible. Look at your budget and see what you can realistically pay. Gather any evidence of your income, bank statements, tax and monthly outgoings.
Speak to your mortgage servicer and explain your situation. Ask about any hardship schemes, repayment options and what evidence you’ll need. Keep copies of any letters, emails, applications or phone calls.
You may also want to speak to free or low cost housing counsellors. Be wary of companies asking for high fees up front, guaranteeing they can stop your foreclosure or telling you to stop making payments. This could be a sign of a mortgage relief scam.
Can You Get Out Of Default?
In many instances you can get out of default. Especially if you act before entering foreclosure. The right option for you will depend on the reason for your financial difficulty, your income, property value and what your lender requires.
You may need to prove you can afford to make your payments going forwards. If you only have a repayment plan for your arrears and it doesn’t make your mortgage affordable then it may only be a short term solution.
It may be a good idea to seek professional legal/financial advice. Especially if you’ve received any foreclosure documents, been sued or are thinking of bankruptcy. Rules can vary depending on where you are.
Final Thoughts
While entering default on your mortgage can be a serious situation, there are often options available to you. Missing payments can cause late fees, damage your credit, result in an official default and foreclosure. However, if you act quickly you may have options.
The most important thing to do is read all letters, contact your lender as soon as possible and keep records of everything. Whatever option you choose (forbearance, repayment plan, loan modification, refinance or selling) acting quickly can improve your situation and help protect your future financially.
