FHA Loans and Foreclosure

FHA, the common acronym for the Federal Housing Administration, is a government agency that insures home loans made by lenders throughout the country.  If a borrower defaults on a loan, FHA reimburses the lender for losses on the loan.  As a result, FHA has an established loss mitigation policy that instructs lenders on how to handle FHA borrowers that are behind in his or her mortgage payments and face the threat of foreclosure.   

FHA outlines five possible options for a home owner facing foreclosure.  Three of these options, referred to by FHA as "reinstatement options", are available to borrowers that face temporary causes for the default.  Reinstatement options include special forbearance where the lender arranges a special repayment plan, loan modification where the mortgage is refinanced or the term is extended to accommodate a lower payment, and filing a partial claim (an interest free loan from HUD to bring the mortgage current).  The other two, referred to as "disposition options", are designed to assist a borrower in the transition to lower cost housing.  Disposition options include a pre-foreclosure sale and deed-in-lieu of foreclosure (voluntarily giving the property back to the lender).

Though FHA does not have a litmus test to determine if a delinquent borrower's situation qualifies for a particular option, FHA relies on the lender to determine a borrower's eligibility.  These eligibility requirements include the type of hardship, the status of the property, and an evaluation of the borrower's financial situation.

A lender will examine the underlying cause of the default and determine if the financial problem is a temporary or permanent situation.  Borrowers that face a permanent financial crisis through death, divorce, or permanent disability and are unlikely to be able to support the monthly mortgage payment will only have disposition options available.  Borrowers that are facing a temporary set back but who will be able to continue making the monthly mortgage payments in the future should qualify for reinstatement options.  

The FHA loss mitigation policy requires that the borrower must occupy the property as a primary residence in order to be eligible for any reinstatement options.  Furthermore, the borrower must not own any other real estate that has a FHA loan against it or had a FHA loan that incurred a loss as a result of a foreclosure or sale of the property.  If a property has been abandoned, the borrower is not eligible for any reinstatement options.  In most cases of abandonment, foreclosure proceedings are initiated instantly.

Critical to determining a borrower's eligibility is the lender's analysis of the borrower's financial situation.  A borrower will be expected to provide detailed financial information to the lender and the lender will be required to independently verify the information.  In addition, any borrower who has filed bankruptcy is not eligible for any options except a partial claim. 

If the cause of the borrower's default or delinquency is one that poses a temporary setback and if the borrower will have the ability to continue making the regularly scheduled mortgage payment, FHA prefers that the lender considers reinstatement options in the following order:  1) special forbearance, 2) loan modification, and 3) partial claim.  If the loan is not curable and/or the borrower is not willing to remain in the home, the lender is to consider disposition options with a preference towards a pre-foreclosure sale and then a deed-in-lieu of foreclosure. 

Special Forbearance

Most lenders will focus on a special forbearance option for borrowers eligible for reinstatement options.  According to FHA's loss mitigation policy, "A special forbearance is a written repayment agreement between a lender and a mortgagor [borrower] which contains a plan to reinstate a loan that has been delinquent for at least 90 days."  Generally a lender will work out a special repayment plan for a borrower through lower payments over a period of time in order to compensate for the unexpected loss of income or increase in living expenses.  

In order for a borrower to qualify for a special forbearance, a borrower must meet the following guidelines:

• at no time may the mortgage be behind more than the equivalent of the total of 12 months of mortgage payments (to include principal, interest, taxes and insurance).  

• the special forbearance must lead to the reinstatement or resumption of the loan by either gradually increasing the monthly payment in order to cover the money owed or the resumption of normal monthly payments.  Furthermore, the loan must be more than 3 months behind but no more than 12 months late.

• the borrower must be an owner occupant and continue to occupy the property as a primary residence during the term of the forbearance.

• a borrower must show that he or she will have sufficient income to reinstate the loan.  This may be accomplished through the gradual repayment of the amount owed or through a combination of a partial claim (see below).

• the property must be habitable with no adverse conditions that would prevent the borrower's continued use or the property's marketability.  

Loan Modification

A loan modification is a permanent change to the mortgage note that restructures the terms of the loan in order to reinstate the loan and results in a payment the borrower can afford to make.  Examples of a loan modification would include lowering the interest rate, extending the due date on the loan, or re-amortizing the remaining balance of the loan.  This option is used for home owners that have suffered a loss of income and do not have the means to continue to make the normal monthly mortgage payments or back payments but do have the means to support a lower payment. 

In order to modify the mortgage, the borrower must:

• be three or more months behind in payments

• have had the mortgage for at least 12 months

• not be in foreclosure

• prove a loss of income or increase in living expenses

• live in the property as an owner occupant and continue to live in the home as a primary residence

Furthermore, the loan modification must result in a fixed rate loan that reinstates the loan.  At the lender's discretion, the interest rate may be set below market or increase the rate if the borrower has the ability to support the payment.  The lender is also allowed to include any or all of the back payments owed into the principal amount.  Any foreclosure costs, late fees, and other administrative expenses may not be included into the modified loan.   

Partial Claim

A partial claim is a no interest loan from the government that covers the amount necessary to reinstate a delinquent loan.  The borrower does not have to make payments for this note nor does the note become payable until the borrower either pays off the FHA loan or no longer owns the property.

In order to qualify for a partial claim, a borrower must:

• be at least 4 months behind but no more than 12 months delinquent

• not be in foreclosure

• have overcome the cause of the default

• have sufficient income to resume the monthly mortgage payments

• not have sufficient income to repay the amount necessary to reinstate the loan

• occupy the property as an owner occupant and continue to live in the home as a primary residence

The partial claim must fully reinstate the loan for the borrower.  The partial claim may only include the principal, interest, taxes and insurance necessary to reinstate the loan.  This does not include any late fees or other administrative costs associated with the delinquency.  Though the partial claim is due when the FHA loan is paid off or when the borrower no longer owns the home, the partial claim does not carry a prepayment penalty.  

Pre-foreclosure Sale

A pre-foreclosure sale allows a borrower in default to sell the property, pay off the remaining balance of the loan, and collect any remaining equity while avoiding foreclosure.  This option is generally used for borrowers who face a financial crisis that requires the sale of the home.  Borrowers whose property value has declined to less than the amount owed against the home are eligible for this option. 

To qualify for this option, the borrower must make a commitment to actively market their home (with the use of a qualified real estate agent) for a maximum period of 4 to 6 months.  During this time frame, the lender must delay any foreclosure action.  The loan must be at least 30 days behind in payments and the borrower must be an owner occupant.

The lender is required to obtain a recent FHA appraisal and preliminary title report for the home.  The property must not have suffered any severe damage and any repair costs must not exceed 10% of the "as is" value of the home.  Furthermore, the home must have a marketable title to the home without any clouds or liens against the home that would prevent the sale of the home.

Should the borrower owe more than the value of the home, the lender may allow the buyer to sell the home for approximately 90% of the appraised value of the home, assuming that the appraised value is at least 63% of the amount owed.  All sales contracts must be approved by the lender.  Failure to sell the home within 90 days of the expiration of the pre-foreclosure sale time frame, the lender will commence foreclosure proceedings or obtain a deed-in-lieu of foreclosure from the home owner.

Deed-In-Lieu of Foreclosure 

A deed-in-lieu of foreclosure is a voluntary return of the property from the borrower by deeding the home to FHA in exchange for a release from all obligations under the mortgage.  A borrower facing eminent foreclosure against the home may voluntarily surrender the home to FHA in order to prevent the foreclosure.  Generally this is the preferred option to foreclosure because it avoids the time and expense of a legal foreclosure.

To qualify for this option, the loan must be in default, the borrower must face a situation where he or she continue to support the mortgage payments, and the  borrower must occupy the home as a primary residence.   Furthermore, the home owner must not own any other properties subject to FHA financing.  

It is advisable for a home owner facing this option to first consider the pre-foreclosure sale.  By deeding the property over to the lender, the borrower loses all accrued equity in the home.  Furthermore, the deed-in-lieu of foreclosure does not release the borrower from any second mortgages or junior liens against the home.  The home owner may face additional issues from the other lenders involved.  Finally, the borrower may be subject to income tax consequences as a result of the deed-in-lieu action.  

However, should a home owner decide to select this option, he or she must complete the deed-in-lieu action within 6 months of the date of default unless an extension was granted by first trying other loss mitigation options or approval from the lender.

Timelines 

In order to qualify for one or several of the options listed above, the borrower must exercise his or her option(s) within the first six months of the default.  Exceptions to this rule apply if:

• the loan is reinstated

• the borrower agrees to a special forbearance

• the loan is modified

• the loan is reinstated by a partial claim

• the borrower sells the property

• the borrower deeds the property back to FHA

• the lender initiates foreclosure

An additional 90 days may be allotted if the lender has initiated but is unable to complete a special forbearance, loan modification or partial claim within the first six months and no other intervening delays (such as a bankruptcy) impede the process.

Negotiating With Your Lender 

As a borrower prepares to speak with his or her lender, there are several key areas to focus on before any interviews begin.  As stated before, FHA relies on the lender to determine a borrower's eligibility to include the type of hardship, the status of the property, and an evaluation of the borrower's financial situation.  Successful negotiations is determined by preparation and good communication.

When preparing for the interview, ask yourself the following:

• Why did I default on the loan?  Is it a result of just not making the payment or have I suffered a verifiable loss of income.  Lenders will listen if you have had a verifiable and temporary set back in income.  The key is being able to support your reasons for being late.  If the reasons are due to temporary layoffs for example, send the lender a letter from your employer stating that you have been laid off.  If you don't have a reason, you may limit your options.

• Can I cut back on my expenses anywhere?  After looking at your income, the lender will analyze your expenses.  Do you really need cable if you face the threat of losing your house?  

• Can I sell an asset to compensate for the deficiency or loss of income?  Do you have any assets that you are forced to make payments on?  Would selling the asset decrease your monthly expenses and/or generate sufficient cash to apply towards the loan?  In some cases a borrower may be able to sell a car, for example, to reduce the monthly expenses by eliminating the car loan.  Also, any profits from the sale of the asset could be used to bring the loan current.  

• Do I know anyone that could loan me the money to get back on my feet?  Do I have any family members, relatives, or other sources that could loan me the money.  Though most people are ashamed to ask, asking a family member, friend or relative may be the only hope of saving the family home.

• Is it worth the effort to save the home?  Would it be easier to sell and start over?  In some cases a borrower may not be able to handle the burden and stress of keeping the house.  

• Should I file for bankruptcy?  When facing a financial crisis, a borrower will often look towards bankruptcy as an option to alleviate the problems.  Before making a decision, determine how bankruptcy will affect your ability to keep the home.

• If I were the lender, would I justify the cause based upon the borrower's situation?  Though this is one of the most difficult questions to ask, be realistic.  If you loaned someone $100,000 dollars, would you believe his or her excuse for being late?  If not, you might want to reconsider your excuses.  Remember that lenders prefer to hear about temporary setbacks versus permanent situations.  

The lender will do a detailed analysis of the borrower's financial situation and scrutinize the reasons for the default  A borrower should compile the applicable paperwork including letters from employers showing a decrease income, bills and receipts justifying an increase in expenses, and prepare to answer the questions about the reasons for the default.  Knowing your situation allows you to talk effectively with your lender.

The second key to successful negotiations with a lender lies in good communication.  Good communication is achieved by quick action, immediate responses, and positive cooperation.  If a home owner knows that he or she is going to be late, the borrower should call the lender.  Ignoring letters and phone calls from the lender actually increases the likelihood that the home owner will lose the home.  

Once the home owner has begun a dialogue with the lender, it is important that the borrower responds to the lender's requests.  The home owner should create a diary of events and log every call, letter, and meeting.  He or she should include the date, time, who called, the telephone number and extension of that individual, and detail what was spoken.  The home owner should keep copies of every letter sent to and received by the lender.  Furthermore, the borrower should emphasize his or her desire to work out a solution to the default each and every time the lender calls.  If the cause for the default has been resolved or will be resolved, the borrower should assure the lender that his or her problems are behind them and he or she is trying to get back on their feet.  The lender will generally be more lenient and willing to work with a home owner if the problem(s) are in the past.

Finally, the borrower should remember to keep a positive attitude.  Threats, belligerent dialogue, and an unwillingness to cooperate does not prove to the lender that the borrower is serious about working out a solution.  In addition, a borrower shouldn't make promises that he or she cannot keep.  Though it may seem like an easy way to stall a foreclosure, a borrower may end up with a higher payment, owe more money than originally delinquent, destroy his or her credit, and may lose the house in the process.

Foreclosure is an expensive process for both the home owner and the lender.  However lenders realize that foreclosure is an effective means to demand payment from a home owner.  A borrower must be prepared and ready to face the consequences of his or her situation.  Knowing his or her options and expectations of the lender are crucial to successfully avoiding foreclosure.  

However, there is free help and assistance for home owner facing the possibility of foreclosure.  If you would like to talk with someone about your situation, click here.