How to Keep House by Paying Off Mortgage During Financial Hardship

Scenario: I live in California and have a house with first mortgage worth of $470K and a second home loan worth of $180K. Due to some financial hardship (I had a divorce and had to pay lump sum alimony), I couldn't make the mortgage payments on time. My first lender has suggested to modify the home loan with a 25-year, interest-only ARM. I am thinking whether or not a Chapter 13 Bankruptcy will suit me better as the second lien can get striped off. However, I can't refinance the property as its value has decreased to about $360K. I also don't have any extra money to reduce the principal amount. A friend of mine has suggested that I go for a short sale. Can you suggest whether I should go for a short sale or make interest only payments for a few years till I can refinance the mortgage loan?

Solution: If you're thinking of whether a short sale or an interest-only ARM will be best suitable for you, then at first you should know about these 2 options in details. If you opt for interest-only mortgage, then you'll have to pay only the interest for a certain period of time. However, this doesn't mean that you won't be able to make payments towards the principal. You can very well do it whenever your financial condition permits you to do so. However, if you have high interest debts, then there's a chance that you'll try to repay them first. As a result, the outstanding mortgage balance will increase thus making it more difficult for you to pay it off in full. So, if you're going for this option then make sure that your financial condition will permit you to make the required monthly pay­­­ments after the interest-only period ends. You can choose short sale and sell off the property for less than the outstanding mortgage balance.

The Government has introduced a program, HAFA (Home Affordable Foreclosure Alternative) as per which the lenders are compelled to allow short sale thereby forgiving the difference between the amount owed and the current property price. Under this program, the servicing bank along with other parties involved in the transaction will get $1000 each. The distressed homeowner will also get $3,500 as relocation assistance. Moreover, a short sale will have less damaging effects on credit report as compared to foreclosure. In addition to this, the lender also assures that he/she will not sue the borrower for the unpaid mortgage balance.

But the question still remains whether or not you'll have to pay the tax on the forgiven amount. The lawmakers of the California State has passed a bill SB 401 that attempts to exempt mortgage borrowers who've lost their homes in a short sale or a foreclosure in the 2009 from state tax on the forgiven debt amount.

The borrowers will continue enjoying this benefit till 2012. You've also inquired whether or not a Chapter 13 Bankruptcy will be suitable in your case. Your second lien may get stripped off if you file a Chapter 13 Bankruptcy. However, to get your second lien stripped off, the value of the property must be less than what you owe on your first mortgage. You'll also have to qualify for the Means Test so as to file a Chapter 13. Considering all these factors, my suggestion would be to go for loan modification.

The Government is offering home loan modification help through HAMP (Home Affordable Modification Program). Under this program, certain lenders are asked to allow the distressed and underwater homeowners modify their mortgage loans and have their monthly payments reduced to 31% of their pre-tax income if they satisfy the qualifying criteria. You may call 1-888-995-HOPE (4673), where a HUD-approved housing counselor may assist you on how to proceed with the Home Affordable Modification Program.

Author -Samantha Taylor is the Community Mentor of MortgageFit and has been contributing her suggestions to the Community since 2005. Not just that, she has also made notable contributions through the various articles written on different subjects related to the mortgage industry. Few of her popular articles would include names like ‘Mortgage that you can afford’, ‘Mobile Home Loan with Bad Credit’, and How much mortgage can I borrow?

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