A mortgage default is a loan status that indicates a homeowner has not made the required payments specified in their mortgage agreement. Failure to make monthly mortgage payments can have various consequences, from negatively affecting your credit history to losing your home to foreclosure.
Homeowners experience various hardships that can lead to home loan defaults. Understanding what mortgage loan default means and how to avoid it – as well as your options if you're in the thick of it – can help you navigate this challenging situation.
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As with other types of debt, a mortgage goes into default status when a borrower does not adhere to the repayment terms in their promissory note. Reasons a lender may consider a home loan to be in default include:
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Missed monthly payments
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Unpaid property taxes
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Unpaid homeowners insurance
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Unapproved transfer of property title
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Unlawful use or acquisition of the property
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Negligent property damage or decay that reduces the value of the home
Let's say you're struggling to keep up with mortgage payments. If you are 30 days late on your monthly payments, your account will become delinquent, which could result in a late fee and a hit to your credit score. Depending on the mortgage lender, you could be delinquent on your loan for 30 to 90 days before it goes into default status. (Some lenders allow even more time).
Read more: What is homeowners insurance, and how much does it cost?
The consequences of defaulting on a mortgage loan can vary based on your situation, state laws, and the terms of the loan agreement. Below are a handful of events that can happen during a home loan default.
Missed payments and late fees
Your mortgage lender or servicer may have contacted you about missed monthly payments. This could include phone calls, a delinquency notice after your first missed payment, and penalty fees for late payments that exceed the lender's grace period.
Because of the unpaid interest and penalties that accrue, letting your mortgage go into default causes your debt to go bankrupt.
Learn more: What to do if you have an underwater mortgage
One long-term effect of a mortgage default is that it appears on your credit record for seven years. This mark lowers your credit score and is visible to all creditors who carry out a credit check on your borrowing habits, for example, if you apply for a new credit card or personal loan.
A default is a sign that you may be a risky borrower with a history of failing to fulfill your promise to repay the debt based on the criteria set out under your loan agreement. To mitigate this risk, lenders may charge you higher interest rates for the privilege or choose to reject your application altogether.
Depending on the laws of your state, loan servicers may need to enable you to remedy the home loan default. This is called pre-closing mediation. Some states that maintain this requirement include (but are not limited to) California, Florida, Illinois, Kentucky, and Wisconsin.
During this time, you can work with an independent mediator in good faith to resolve the default and restore your mortgage loan before the property is officially closed. As a borrower, this process is completely voluntary, and to be successful, you and the borrower must reach a mutually agreed settlement offer. Remember, however, that the lender is not obliged to accept your application.
If you and the lender cannot come to a negotiated agreement during the mediation period, the property moves on to foreclosure. Depending on the terms of the loan agreement and state laws, the borrower will file for foreclosure through a judicial hearing against the homeowner or execute a nonjudicial foreclosure that does not require a lawsuit.
Lenders or servicers who are awarded a judgment in their favor during a judicial foreclosure – or who have fulfilled the requirements of a non-judicial foreclosure – can then proceed to advertise the sale of the property.
Read more: What to expect when facing foreclosure
During a mortgage loan default, a lender may choose to use the acceleration clause on your home loan agreement. This clause gives the borrower the right to demand full repayment of the principal interest payments of the loan that have not been paid to date. If the foreclosure process has started but has not yet closed, you can choose to pay off the entire debt quickly to stop the foreclosure and cure the mortgage default.
Some reasons for debt acceleration include events such as a borrower filing for bankruptcy, not paying property taxes, or continuing to miss monthly mortgage payments.
You may experience mortgage default due to a series of events that are out of your control. For example, a sudden and severe loss of income or unexpected medical bills could strain your resources, leaving you unable to afford your mortgage payments.
Depending on your situation, you may be able to strengthen your financial stability before these difficult scenarios arrive or get help earlier in the process to avoid mortgage loan default. Here are some tips for avoiding mortgage default:
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Build your emergency savings. One way to survive unplanned financial upheaval is to already have a comfortable financial safety net. Based on your budget, set aside a manageable and reasonable amount of emergency savings If a financial crisis arises, you will have some money to put towards your mortgage payments until you get back on your feet.
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Contact your lender as soon as possible. If you have the slightest idea that you may not be able to make a monthly payment, contact your mortgage lender or servicer immediately. If you just need a few extra days to get your money or you're dealing with short-term hardship, for example, the company may extend your grace period or put your loan in forbearance for turn to avoid offence.
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Refinance your mortgage loan. If you haven't missed a payment yet but would like more manageable repayment terms, consider refinancing. With a mortgage refinance, you take out a new loan to pay off your original one. This new mortgage has a different term length and interest rate. Depending on the refinance and your qualifications, this could help you secure a lower mortgage rate or lower payment.
Learn more: The best mortgage refinance lenders
Even if you are in the midst of a mortgage default, you may still have options to soften the blow in the short term. However, keep in mind that all of the routes below can have a negative impact on your credit.
If you have defaulted on your mortgage or are at risk of defaulting, a loan modification could be the answer—if your lender is willing to do so. While refinancing replaces your original mortgage with a new one, a modification changes your existing home loan. It changes repayment details in your loan agreement in the short or long term. Modifications could include a temporary reduction in the mortgage rate or an extension of your loan period.
This method has its share of caveats, including potentially paying more towards your home over time if your lender gives you a longer loan term.
Read more: How to apply for a loan modification if you are struggling to make monthly mortgage payments
A short sale could be a solution for cash-strapped homeowners if you owe more than your home is currently worth. In a short sale, the homeowner voluntarily agrees to sell the home and direct the sale proceeds to the lender. In return, the lender agrees to lift the lien on the property.
Unless the lender agrees to forgive the default, the homeowner is still liable for any unpaid mortgage loan debt. Additionally, if the lender forgives any amount, it may be considered taxable income on your tax return.
Learn more: How a short sale in real estate works
Another option, if your mortgage is in default (or may soon be), is to file for bankruptcy. Bankruptcy requires a court proceeding, and during this time, the lender's efforts to foreclose on the property are delayed.
Chapter 7 bankruptcy is only available if you are current on your monthly payments, so it is for homeowners who are at risk of default but have not yet reached that point. Under Chapter 7 bankruptcy, your assets are liquidated and mortgage liability is discharged, but you could still lose your home to foreclosure if you continue to miss payments. Alternatively, Chapter 13 bankruptcy lets you cure your mortgage default over time through a court-approved payment plan over three to five years.
Dig deeper: Can you file for bankruptcy and keep your house?
When your mortgage loan defaults, your lender can take certain steps, such as accelerating the debt so that it is due upfront rather than in installments over the term of your loan. It can also initiate foreclosure on the house, and you may lose your home if you do not resolve the default.
After missing one mortgage payment, the account status is likely to be considered “delinquent” on your credit report. After three months of non-payment on your mortgage loan, your lender may begin to foreclose on the loan. If left unresolved, the continued non-payment can result in the lender taking possession of your home and selling it to recoup the loss.
If you can't pay your mortgage, contact your lender or loan servicer right away to learn about your options. For example, you may have access to a short-term forbearance or loan modification that helps make repayment more financially manageable. Examples of modifications include extending the repayment term of the home loan or temporarily lowering the mortgage rate.
This article was edited by Laura Grace Tarpley.