A well done piece.
This seems to be THE NUMBER ONE question I get. Unfortunately there are several answers and which is correct for you depends on the Circumstances. I will address the common scenarios in this article.
Policy in my office is to never "tell" - as in "instruct" - our borrower client to pay or not to pay their mortgage. Paying or not paying has a lot of collateral effects and the borrower needs to know what they are before making the decision. We don't make the decision for the borrower (our client) because the effects of paying or not paying are not going to affect me - but they will affect the client, so it is the client that must make the final decision.
Let me make one issue clear - when we are hired to help facilitate a short sale or loan modification it is far easier for us to negotiate with the lender if the payments are late, but it is almost never a requirement. The exceptions to which will be discussed later in this article. Additionally, internal rules change at the banks constantly. A new client came in totally frustrated. They called their bank to help with a modification and the bank said they could not address their situation until they were at least 60 days late. So the near perfect (800+) credit score couple stopped paying for 60 days and then called the bank back. Now the bank says that because they are 60 days late they cannot speak to them about a modification! The point is, if you don't have to be late then why voluntarily create a late payment credit history that will adversely affect your credit-dependent life almost immediately and for years to come?
SO LET'S GET INTO IT - Danger - this is a long article and it covers a lot of ground!
A borrower that is current and contemplating a short sale wonders if they should stop paying their (first) mortgage. They are upside down and until now they have been current. However they are paying the mortgage at a cost of not paying other bills. (Other or different facts may be that they are paying all their bills but taking the money from savings or a pension fund to make those payments, or they are borrowing money from another equity loan).
Generally, it is not a good idea to get into debt to pay your mortgage, unless you have a solid plan to both (i) keep the mortgage current and (ii) repay the additional indebtedness you are creating. It is not like taking from one pocket to put into another - it is more like taking from someone else's pocket to pay your bills. This would include credit card loans as the source of funds. It all has to be paid back, so if you don't have a plan to pay it back, don't borrow it in the first place! You are only digging a bigger hole for yourself and making it harder to get out of the hole.
If you are taking from your pension or savings money, again you better have a rock solid plan to get that money back into those accounts, or there is no sense in giving up that hard earned and usually irreplaceable retirement money, especially considering these are monies that are usually protected from creditors' judgments including those your mortgage lender could obtain (deficiency judgment)..
Of course the "amount" of money you have "in reserve" comes into consideration. If you have 2 million dollars in reserve and you decide to spend 10% of it to keep the loans current until you can short sale the property, that plan has a basis that the 10% is not going to make a difference in the way you run your life over the remaining time you have left as a mere mortal.
Sometimes, but rarely, we run into a lender that says they won't approve a short sale or modification because the borrower is current with his payments. When we have encountered this it is in most cases associated with a government backed loan, (but later on we will show you why this may be motivated by plain greed on the part of a loan servicer). A properly compiled financial snapshot of the borrower should show why they are current and what will happen if the short sale or modification is not approved.
Your decision on how to proceed should be based on what goal you are trying to accomplish and how you plan to get to that goal (see how to determine your goal).
Apart for some voluntary government programs regarding (Fannie Mae or Freddie Mac) government involved mortgages, I know of no lender that absolutely will not deal with a borrower who is current with their mortgage payments. Lenders deal with all sorts of situations and "absolutely not" is just not in the vocabulary. A typical borrower calling a lender may hear that they must be late, but that is more of a "vetting" statement than an absolute policy.
The exceptions are some government program guides for modification. The first step to seeing if your loan comes within this exception is to see if it is a Fannie Mae or Freddie Mac loan. You can do this online at the Making Home Affordable site. Many servicers and lenders whose loans are not "government backed" are now choosing to follow this government plan (known as the Home Affordable Modification plan or more affectionately called the "Obama Plan" - see below) for the simple reason that they are being compensated by the government for each successful modification they execute within its guidelines, and either the servicer or lender receive a residual bonus for the loan staying current under the modification. In these cases we have seen non-government backed loans insist on the borrower being late to qualify for modification as well. What is confusing on this point is that when the plan was introduced it included modifications (and compensation for such) for current loans as well. However, we are told time and time again from the lenders directly that they must be late to qualify. There is no such rule in the guidelines.
While this is contrary to what has been published by the government about the plan, keep mind that following the plan and any of its various aspects is entirely voluntary and up to the Lender or servicer. They can pick and chose from this plan as they see fit for their own internal reasons. Here is a more interesting twist - a servicer that modifies a delinquent loan is paid more under this incentive plan than if the borrower were to modify while the loan is current! If the borrower is current, the servicer can receive up to $3,500 in incentive fees from the government. If the borrower is delinquent, the servicer can receive up to $4,000 in incentive fees from the government. Thus it seems that it pays ($500 to)the servicer to encourage a borrower to be delinquent!
We often see a client that fits the profile for modification under this government plan. Some of these plans are said to require that to be qualified the borrower must be late 60 days (see Guidelines page 5 at bottom). But in fact, being late is not a requirement, but only one factor of many (see Guidelines page 16 at the top - "However, a NPV (net present value) positive result is not necessary to qualify a loan for a Home Affordable Modification"). If the goal is to qualify under such a plan as put in place by the lender at that time, then to accomplish that qualification the borrower may need to make themselves late, but that cannot be determined in a 2 minute telephone call with a lender representative. I cringe when we go this route because just like these "plans" came into existence, I can see them change the plan thus leaving the now 60 day late borrower with ruined credit scores that occurred needlessly.
Generally about a quarter of our modification clients never go late and still get a modification offer from the lender. However, keep in mind that nearly all lenders put up as their first line of defense the policy that going late is a necessity to qualify. We can only speculate this is done to deter the enormous inflow of loan modification requests from borrowers that would come in if this was NOT said to be a requirement. It also helps address those in the most dire amount of need first.
The Pro's and the Con's:
The general rule of thumb we use is if you can pay your mortgage and maintain your life's necessities, you may consider keeping the loan current, taking the points in this article into account. However, if you need to choose between buying food or medications and paying the mortgage, the decision that should be made is clear: your life necessities take precedent.
Here are the pro's to consider when in the short sale or modification process. Keeping the loan CURRENT has the following benefits:
a) Your credit score is not dinged until the short sale transaction occurs (and not at all in most loan modifications) and your overall credit score reduction will be minimized, and b) You will remain in good standing with your lender without worry of penalties, fines, or a foreclosure.
The "con's" of keeping the loan current are that:
(a) You will be out of pocket for the monthly mortgage payment (monies which you may or may not need to survive), and
(b) Your lender may question the sincerity of your claimed hardship, and you may be spending funds that would otherwise be potentially (but rarely) forgiven by the lender. In addition, occasionally the lenders in a short sale may require a lump sum payment above the sale amount from the borrower to forgive the debt. Coming up with that money is sometimes the difference between a deal or no-deal. If you can put your mortgage payments aside and stockpile them, it will help you cover that potential lump sum.
A similar pro/con approach applies to GOING DELINQUENT with your mortgage. In favor of going late is being able to keep the unspent mortgage payments in your pocket (or applied towards other necessities as the case may be) in which event your hardship may appear more sincere to the lender. On the other hand, there are very real consequences to going late with your mortgage payment:
a) You WILL incur late fees and other penalties on the late interest. Usually this is not a large issue as it is part of the forgiven debt in a short sale and usually forgiven in a modification, but it is something to consider,
b) Your credit score downgrade will be harder as you will compound the short sale hit with a 30 day late, 60 day late, etc, (and if this is a modification you will make a non-negative credit score event turn into a negative credit score event), and
c) You will eventually cross a threshold (typical industry standard of 90 days late) where the lender will initiate a foreclosure action in State court.
Going Late on Your Second Mortgage:
Often a borrower comes to us and says that they are late on the first mortgage but current on the second mortgage. The second mortgage is almost always totally upside down with no equity left in the property to secure that financial obligation. The borrower says they paid the second mortgage because they had the money for the smaller payment (second) mortgage but not the larger amount first mortgage. Our answer - if you don't pay the first mortgage they are going to foreclose it and then paying the second mortgage is not going to save your house.
Lately we have seen second mortgage lenders with 90 day late mortgages skipping the foreclosure process (since if they cause a sale of the house it is sold subject to the first mortgage, and thus any buyer still has to pay the first mortgage, which usually makes no economic sense). Instead the second mortgage lender sues the borrower on the promissory note only and gets a money judgment that they can keep for a long time (20 years in Florida).
So if a client says they are paying the second mortgage but not the first mortgage, we usually suggest they look at the common sense approach and what are they likely to gain or lose by doing so.
Effect of Non-Payment / Late Payment on Credit Score:
This is a big question and nowhere is the answer clear cut. Definitely if you get a report on your credit that you were "late" (in mortgages that means 30 days or more late) then your credit has been "dinged" and your credit score is adversely affected.
Credit scores are used for many purposes, including the amount of credit you can get on a credit card, the interest rate you get on credit cards, car loans and mortgages, your ability and price of life and disability insurance and even car or house liability insurance, your ability to get a certain type of job, or to establish business relationships, and your ability to rent a place to live, to name a few. So credit scores are important. If you want to better understand credit scoring you can see the Federal Reserve Board's Report to Congress from April 2008.
How much your credit score is affected by a 30, 60 or 90 day late report depends on a lot of other factors about your financial well being, your past credit history and myriad other issues. Generally though we have our clients reporting drops of as little as 50 points for a no late payment short sale or up to 150 points for a short sale with multiple late payment reports. We have seen an 800 go to 720 and we have seen a 740 go to 500. It all depends on too many uncontrollable credit issues to be able to give a formula that works for everyone. For a discussion on credit scores this our past article.
Rightfully so. The fact of the matter is that we are in uncharted waters and there is no industry standard for Short Sales or Loan Modifications, which makes pinning down exactly what the Lenders may do near impossible. Pile on the fact that there are a large number of lenders out there and each have their own internal policies which change as readily as the tides. The best anyone can hope to do is make an educated decision, set a plan, and be ready for anything.
Copyright 2009 Richard P. Zaretsky, Esq.
Be sure to contact your own attorney for your state laws, and always consult your own attorney on any legal decision you need to make. This article is for information purposes and is not specific advice to any one reader.
Richard Zaretsky, Esq., RICHARD P. ZARETSKY P.A. ATTORNEYS AT LAW, 1655 PALM BEACH LAKES BLVD, SUITE 900, WEST PALM BEACH, FLORIDA 33401, PHONE 561 689 6660 RPZ99@Florida-Counsel.com - FLORIDA BAR BOARD CERTIFIED IN REAL ESTATE LAW - We assist Brokers and Sellers with Short Sales and Modifications and Consult with Brokers and Sellers Nationwide! Shortsales@Florida-Counsel.com New Website www.Florida-Counsel.com. See our easy to find articles at SHORT SALE AND LOAN MODIFICATION TABLE OF CONTENTS