Foreclosure is a very real threat that many people are facing today. When you get to the point where you are having trouble repaying your home loan, your financial situation can feel overwhelming. It can be tempting just to let the foreclosure happen and to start fresh later with a new home loan. However, this can be a huge financial mistake that affects your credit score and your long-term potential to get good loans.
First, you lose your home
When the bank forecloses on your mortgage, you lose your home. As if the prospect of homelessness wasn't terrifying enough, foreclosure has financial consequences ranging from annoying to severe:
- You give up the investment that you made in your home. Investing in real estate can be a smart financial choice, but foreclosure means that you lose out on that investment.
- You need to come up with money for housing. Unless you will be moving in with a family member, you now must come up with a deposit and first month's rent for a new place to live. Many people end up taking credit card cash advances that put them in even deeper debt.
- There may be a tax penalty. After foreclosure, your home will be sold. If it is sold for less than what you owed (which is common) then you may have to pay taxes on the difference.
Next, your credit score gets trashed
When the bank forecloses on your home, your personal credit score takes a huge hit. The financial consequences of this include:
- Getting credit becomes very difficult. A mortgage is probably the biggest loan you'll ever have. Lenders don't want to take on the risk of a borrower who defaulted on a major loan.
- Any new loans that you take out, including mortgages, will have a high rate of interest. You will end up paying a lot more to take out loans than if you didn't have this hit on your credit report.
- You will need a much higher down payment amount to buy a new home in the future.
Alternatives to home foreclosure
The financial consequences of allowing your home to foreclose are steep. Before the bank comes knocking on the door, take stock of your situation and figure out if you can afford to stay where you are. Consider the following alternatives before you get stuck in a foreclosure.
- Refinance your home mortgage. A mortgage refinance can reduce the cost of your home loan and make it possible for you to make those payments. If you know that you're about to fall behind on your mortgage payments, then it's a great time to look into this option.
- Request a loan modification. The process of modifying your loan can be difficult, but it's an option for people who are underwater (they owe more than the home is worth) even if foreclosure proceedings have already started.
- Sell your home. Although you might have to take a loss, a private home sale may provide you with the money that you need to pay off the mortgage loan. You can then find a more affordable place to live. Although you still lose your home, your credit score won't be affected and you can make a clean start.
- Get a deed in lieu of foreclosure. You turn over the property to the lender instead of allowing them to foreclose on you. This is a last resort option that offers slightly better financial terms than a traditional foreclosure.
Can you think of a time when it makes financial sense to let your home be foreclosed? Share your thoughts in the comments.