What Happens When You Stop Foreclosure

After my Tuesday Tutorial last week, a great attorney and friend emailed me…

“The spouse is required to execute the DOT to avoid any homestead claims if they reconcile and he moves in and then she defaults. I’m not saying he would prevail on the homestead claim, but what a hassle. I’d take the case to stop a foreclosure.”

I responded:

Lenders and title insurers don’t care because a vendor’s lien is superior to homestead interest.

To which he responded:

“You kid yourself if you think judges understand the difference in liens, but they all understand homestead, or think they do. I could buy nine months staving off the foreclosure.”

So, I responded with my treatise which I have named

“What Happens When You Stop a Foreclosure.”

I continue my correspondence:

As you have probably discerned, quickness of mind is your strong suit and not mine.

You have given me feedback these past few years – and, knowing how valuable an attorney’s time is, I sincerely treasure that feedback and instruction. I often muse that you had to explain partitioning property during a marriage about 3 times over lunch that day and then in a series of emails over the next several months. If you would help me and become a mentor of sorts to me, I would like to have the equivalent of a law degree by the time I retire (around age 95). I don’t want to practice law (as I fancied when I was quite a bit younger). I just want to know what I’m talking about.

An attorney was quite pleased to tell me one day (at the Family Law Section luncheon where I was speaking) that he had filed bankruptcy on his client’s behalf so as to stop a foreclosure. I remember that it didn’t sit well with me but I had no immediate response. But, I have mulled it over many times – this idea of “stopping foreclosure.”

In the legal world, it sounded like a clever move – something that stopped a big bank from taking someone’s house from them. The classic scene - little guy stands up to the big guy. Yet, as a financier who deals with people and their credit at times well after such a scene has played out, I knew that a legal “win” was actually a net loss. The homeowner, ultimately gained nothing and lost much. That is, the only benefit of stopping foreclosure is to simply forestall for a few more months that which is inevitable – the occupant has to move out of the bank’s house. And I ask myself - is moving out in October truly preferable to moving out in March? I suppose it depends on a few other considerations.

Here are a few things that happen when a foreclosure is delayed:

1. The borrower’s credit worsens. Think about it. Each month, the mortgage shows one more month late. First, it’s 30 days late, then 60, then 90, etc. It would be better for the credit of the borrower if he could get the bank to take the house and sell it after only one late payment than to pile up 4 months or 6 or 9 or 12 months of late payments. These late payments are disastrous to credit scores and rating; and, each month that the mortgage is late again adds even more months to the length of time required for the borrower to recover. Because of credit scoring, it’s not a one for one – it could take several months for scores to recover from just one 30-day late payment and certainly from a 120+-day late payment. In other words, four months of late payments in a row, totaling 120 days late will substantially lower the borrower’s scores. But, that borrower’s scores will not rise again to their pre-foreclosure level just because they make 4 on-time payments in a row. We don’t know the precise metrics but, credit scoring projects (the effects of) a bad pay history into the next 12, 24 and 48 months and even longer.

2. The balance of the loan continues to grow. Interest and minimal principal payments accrue along with legal fees which can easily be in the thousands. There are firms, as you know, that specialize in pre-foreclosure loan servicing. It’s a science…and a costly one to the borrower. And, additional to those fees are the ones to the attorney who has “stopped foreclosure.” So a regularly amortizing loan becomes a negatively amortizing one, immediately – with additional fees on top of that. To put it colloquially, each month foreclosure is stopped, the deeper the hole which is being dug.

• Note: do you remember the financial crisis 2008-2012? People were trying to strategically default on their mortgages, mostly because they were upside down on the house and just wanted to walk away. Thousands were frustrated and in despair because the banks could not foreclose quickly enough and allowed many mortgages to go 12 months or longer in default, causing the borrower’s credit to be damaged in ways that would take years to repair while costing the borrowers untold amounts of money in higher credit rates if they could even get credit.
• Note 2: There are programs to “help” people stay out of foreclosure. But, these have negative consequences as well. For example, if the servicer has added the defaulted amount onto the “back end” of the loan or if the homeowners had modified their mortgage, they are not eligible for refinancing for 2 more years and maybe even longer.

3. For most cases, when a mortgage is 4 months down, it’s considered – in the mortgage credit world – a foreclosure anyway. Foreclosures, then, start a time line of 3, 4 or up to 7 years (depending on the program) before which an applicant will not be lent mortgage money. It doesn’t matter if the borrower catches up late payments and fees and begins paying their mortgage on time after that. Many, if not most, lenders have this “overlay” in their underwriting guidelines. It’s not required by Fannie or Freddie that it be viewed as a foreclosure. But, even the lenders that would waive the seasoning requirement (3, 4, 7 years after foreclosure) require that a very good description of “extenuating circumstances” be given. Divorce, by the way, is NOT considered an extenuating circumstance. Losing one’s job during the aftermath of the 2008 financial crisis IS an extenuating circumstance and even named specifically by Fannie Mae as an acceptable explanation of financial difficulty. Again though – this does not remove the disastrous looking credit report or raise scores, it just gives underwriters the ability to approve loans once the borrowers’ scores have ascended to an acceptable level but still have these negative events showing on their credit report.

May God and the Texas State Bar forgive me if I have veered off into giving legal advice or instruction. I confess that I am completely unable to do that. But, I have tried to give you the view from the world of credit, from the real world of actually trying to finance people’s home (purchasing and refinancing) – the view from “the trenches” so to speak. That’s what was going through my mind that day in Frisco when the attorney was touting his legal maneuver of “stopping foreclosure.” I was thinking about the disastrous looking credit report and how long it would take for his client to recover and be able to get financing again.

My friend responded with…

“My pleasure, Noel. There could be many reasons to stop a foreclosure; more time to sell, more time to find a new job and catch it up, more time to find new housing. Usually when someone is on the verge of foreclosure, credit score is the least of concerns. Also, credit can be repaired. Foreclosures and BK are forever although they do come off the credit report eventually.”

Now you see why I am so fond of this gentleman.

My only rebuttal to his last point is that there is no difference between credit in need of repair and foreclosures/bankruptcies on the credit report. Those things ARE what constitute “credit in need of repair.” Other things (like late payments) for sure. But, the reality is that the many late payments that precede a foreclosure are so devastating to the credit profile and scores it is very conceivable that it takes years to recover…perhaps the same number of years which foreclosures and BK’s need to season.

At least my friend has an eye for helping folks in need which I’m sure is the ethos behind “stopping foreclosure.” Just thought you guys would like to know what happens in the credit world when such things are triggered.