Foreclosure and Debt: Should I pay down debt or save money (or both)?

06 Feb

Paying unsecured debts in a timely fashion is important to maintaining credit in any instance; however, it can be argued as being more crucial when a mortgage or any other major credit item is reporting as late. The math is simple: although FICO does not weigh one’s credit items universally equal, the lesser percentage of your overall open credit accounts that report past due at any one time, the less significance the delinquent accounts have on pulling your score down.

familyIn addition, aggressively paying non-mortgage debts down/off may also serve as a constructive use of money for those who are looking to exit homes via foreclosure due to unaffordability. In non-recourse (void of deficiency judgments) states like Minnesota, homeowners may be able to avoid having to couple their mortgage default with a bankruptcy by paying their non-mortgage debts. Lastly, homeowners who may have already filed bankruptcy in the past 8 years and cannot reclaim protection under Chapter 7 may have to apply similar methods out of necessity to dodge involuntary collection – hoping that by the time the bank reclaims the home, enough debt will be paid off to afford a rental (that in some cases may actually cost the same or more as the foreclosed mortgage).

Though the combinations are endless, as not any single mortgage delinquency is the same, there are instances when it’s good to pay other debt when delinquent on your mortgage…and there are situations when doing so will reappear in hindsight as being just plain foolish.

“But I really want to keep my house.”House in winter

You have fallen behind on the mortgage due to having a short- or long-term reduction in income; an unexpected expenditure landing on your lap; or rising costs of goods and services are competing for the money you’ve always made. In a sense, it is easy to let the mortgage fall past due since it’s your largest single expense and by doing so, you are not only able to pay all your other expenses but you may even have a little money left over, which feels good since you’ve lived paycheck to paycheck for so long. You hear that there are modification programs that may be able to get you back on track and even may be able to reduce your payments to make things more affordable. So you contact your lender and you start the application. What the vast majority of homeowners in this situation fail to understand is that the way they are handling their other debts has a significant impact on the way their lender views their hardship and formulates the decision to allow the homeowners to stay or to move ahead with foreclosure.

Your other debt is not a hardship to your mortgage company.

Divorce, spousal death, irreversible disability, being laid off and underemployed when returning to work, being involved in a natural disaster, documentable & debilitating illness – these are hardships for which lenders explore options. Needing a 2011 Ford F-150, getting duped into a timeshare you can’t get rid of and overspending your budget since the Clinton administration until your collective credit card balances rival your annual income – not so much an avoidable hardship recognized by your loan servicer. Understand by looking at guidelines and speaking with a certified HUD housing counselor what is considered “affordable” for you by the bank and what a realistic range of potential payments is if your loan is modified. For instance, the federal HAMP program (Home Affordable Modification Program) designates that affordable housing is defined as having your mortgage at or less than 31% of your household’s gross income. So if your current mortgage consumes 21% of your household gross income and other debt takes up 16% – then it may not be advantageous to put all your hope and proverbial eggs in your mortgage company’s basket as chances are, you need more help then they can provide.

 

Continuing to pay other debt may be harmful if by doing so you are actually proving you can’t afford your house.

Credit card stack

Most mortgages have an acceleration clause that instructs the servicer to stop taking payments around 90 days past due so that they can start the legal default process regulated by individual state law. It is always recommended, if your intention is to save your house from foreclosure, to continue making full payments for as long as you are able. This will hopefully slow acceleration and illustrate to the lender that you are both trying and are able to somewhat afford the payments, despite being imperfect. However, once the lender stops processing payments, it is important to take the money that otherwise would go towards payments and save it. This will continue documenting your level of affordability and to either build down-payment money for a potential workout option or emergency savings if the money isn’t needed to solidify your probability of being successful with a modification. However, if in reality you are unable to pay other debt and to save money while not paying your mortgage, it directly contradicts your assertion that you would be successful with another chance from the lender.

Paying more than the minimum toward debts isn’t recommended if it detracts from saving.

The reality is that for every household submitting modification paperwork intending to keep their property, there is another involved in the same process fully intending on foreclosing, yet hoping their efforts will delay the inevitable departure from the property. Though I understand the logic in using the money that the mortgage company is not taking in their review process and applying it towards paying off debts that would aid the comprehensive ability to later afford a modified mortgage, it also somewhat represents the behavioral pattern of people who are oftentimes insincere about their efforts. Overpaying or settling debts detracts from the pattern of savings that those who tend to be successful with modifications exercise. If you are denied a modification or other option, can’t accept the offer that is provided, or don’t need the savings as down-payment money – then you can always use it later to pay down debt as you see fit.

Resist new debt.

This seems like it would be obvious, but should be restated. If you are entering a hardship and feel that you may have to discuss options with your bank regarding your mortgage, don’t buy vehicles or recreational items on credit. If you are already in the hardship, resist from opening credit lines to pay for consumer goods or services. For instance, if you are 6 months delinquent on your mortgage and have little money saved, charging your child’s school clothes on new store cards is not the message of stability you want to send.

If intent on default, paying other debts can be harmful, too.

If the math indicates that you cannot outrun enough debt to later pay for the cost of rental housing, continuing to pay debt will usually be regretted later and seen as spending good money after bad. I always advise homeowners to look at what the comparative cost of rental housing is when entering a hardship. This typically helps them gauge the importance of fighting to keep the home they have mortgaged (if payments are less or similar than renting something they may not like as much) and to make hard decisions about other debt if it simply is not compatible with housing, period. Let’s face it, foreclosure is a major life event and though unfortunate and unsettling, it should also be an opportunity to grow. There is no point in leaving a foreclosure situation utterly broke with lingering problems unresolved – unless it is absolutely unavoidable.

There are other options to consumer or unsecured debts – including bankruptcy, internal hardship programs, debt management programs, and self-administered debt settlement programs (it is never advised to pay a 3rd party company to settle debts for you). However, just like your other debts are not considered a hardship, your desire to avoid contingency debt options is simply not a valid argument for your lender not to naturally explore foreclosure as a result of your inability to provide for the mortgage.

My advice on saving money to document affordability isn’t just an idealistic tidbit; it comessave money from working with many hundreds of families over the past 5 years and seeing a very real trend between those having some level of savings, reassuring the bank they are ready to move forward being offered modifications, and those with hardly anything saved being denied. Really, can you blame an underwriter’s natural observation that you may not be stable enough to succeed with a modification if you don’t have the money to even begin one? In the end, it is always prudent to ask yourself, when deciding what to do with your money while hoping to keep your home in the process of default, what is truly in the best interest of the mortgage?

Times can be tough and we’re here to help you take action. If you or someone you know is in a similar situation and would like an unbiased opinion to help you determine your next steps, call LSS Financial Counseling at 888.577.2227. You can also START ONLINE COUNSELING right now. Want more information about LSS Financial Counseling? Visit our website.

Author Tim Fischer is a Certified Financial and Foreclosure Prevention Counselor with LSS and specializes in Foreclosure Prevention Counseling.

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