It’s a burning question on millions of minds…. what do I need to do to avoid having my house foreclosed on…. Attorney Edward Gonzalez*, who practices bankruptcy in Maryland, DC and Virginia,  is a strong consumer advocate. We list him on our website’s consumer-friendly bankruptcy attorney listing. And he wrote a wonderful white paper called “Residential Real Estate Crisis.” In it he answers every question imaginable, starting with the very moment you realize that you’re falling behind on your mortgage. One big question is what your options are for avoiding foreclosure. Ed was kind enough to let us share his answer to that question. If you’re worried about foreclosure right now,

What do I do to avoid foreclosure?
Worried about foreclosure? The following are your major options. The best option for you will vary, depending on the time you have before foreclosure, the amount of equity in your house, and your current financial situation:

1) Sale before foreclosure. 

– Pro: This is the best option.  You pay off the debt in full and preserve your credit.
– Con: You have to have enough time before foreclosure, and you have to have enough equity in your property to reduce the price for a quick sale and still fully pay off the mortgage (as well as paying the costs of sale and real estate agent’s commissions).

2) Refinance. This can be effective, if the only problem is monthly payments that are too large.

– Pro: Reduces monthly payment so you can meet the mortgage obligations.

– Con: The value of the house must be high enough to serve as collateral to cover the new loan in full.  If you bought during the 2005-2006 peak of the market and put little or no money down, the value probably has dropped, so this is not likely.  Furthermore, if you have missed payments, your credit score has dropped making obtaining a new loan more difficult.

3) “Short sale.” In a “short sale,” the lender agrees to take less than the full balance owed on the mortgage and permit a sale to close by releasing his lien.

– Pro: You sell the property and avoid foreclosure.

– Con: You need the agreement of the lender or lenders, if you propose to pay them less than what is owed.  Lender cooperation is absolutely voluntary.  The lender cannot be forced.  Each of the lenders is different, and none are easy to work with to obtain this agreement.  You will need to provide financial information on yourself showing inability to pay off the loan in full from personal assets, and probably a showing from the realtors that you cannot get a higher price.

Furthermore, some lenders cannot agree to a short sale, even if they want to because the loan has been sold to investors as bonds with strict rules about what can be done with problem loans.  They are forced to proceed to foreclosure.

If the lender does not “waive the deficiency,” and continues to hold you personally responsible for the loan, you must still personally repay the lender the deficiency, possibly over time, with or without interest, depending.  For example, if the sale is short by $50,000, you must pay that back to the lender.

If the lender does waive the deficiency and “writes off” the loan, he will report the cancelled deficiency to the IRS and state tax agency, so you must report that as taxable income and may have to pay income tax on that amount. For example, if the sale is short by $50,000 and the lender waives that deficiency, you will have taxable income in the amount of $50,000 for that year. If your tax bracket is 25%, you may have to pay $12,500 in additional tax at year’s end to the IRS (and whatever state tax is due). Whether you will be charged with tax, depends on whether your situation fits under the exceptions or exclusions, including a surrender of the property while in bankruptcy, or while insolvent. 

4) “Deed in Lieu of Foreclosure.” Similar to a short sale, the borrower conveys the house to the lender in return for stopping enforcement of the loan.

– Pro: Avoids foreclosure.

– Con: The lender may or may not forgive the deficiency.  (The other consequences are stated above in “short sale.”)

5) Surrender of the property in Chapter 7 bankruptcy. In bankruptcy, a debtor is discharged of most debts, including personal liability on mortgages.  Chapter 7 bankruptcy is a “liquidation” of the debtor’s property.  Basically, he turns over his assets — subject to exemptions in the law for basic property he needs to live — in return for the discharge of his debts.

In regard to his house, in Chapter 7, the debtor gives it up to an attorney (called a “trustee“), appointed by the court to sell his property for the benefit of the creditors, or surrenders the collateral to the lender, while being freed of the underlying debt.

In addition, the debtor may be able to keep the house, if the property has no equity and does not interest the trustee, and the debtor can raise the money to pay the lender the arrearage quickly plus pay the monthly payments going forward.

6) Stop a foreclosure through Chapter 13 bankruptcy and either “cure the default,” or gain additional time to sell the house. In Chapter 13 bankruptcy, the debtor also discharges debt.  The difference is that the debtor pays into the court through a plan of reorganization he proposes, and approved by the court, funded by his earnings or sale of assets.

This type of bankruptcy provides great flexibility to the debtor to keep property that is not protected in Chapter 7 or to hold on to valuable property he wants to keep. The plan provides for repayment of the arrears for the house he wishes to keep, payments going forward, and full or partial repayment on other depending on other factors.

If you want to know whether or not it’s time to file bankruptcy, visit Paula’s blog for more articles and information!

*Edward Gonzalez, Esq. focuses his law practice on financial matters for individuals and small businesses. He obtained his agency experience working for the Internal Revenue Service from 1988 to 1993. He has been in private practice since 1993 handling cases in the state courts of Virginia, the District of Columbia, Maryland, and the federal and bankruptcy courts for the District of Columbia, Eastern District of Virginia, and the US Tax Court. Check out the full report on Ed’s website: