Other Options for Homeowners Facing Foreclosure
NOTE: Glossary words are highlighted. Click on any glossary word to see its definition.
If I can't keep my home, can I still avoid foreclosure?
If you have not been able to modify or refinance your loan, and you realize that you cannot keep your home, there are several alternatives to foreclosure that you might want to consider. You should discuss these options with a foreclosure counselor and lawyer before deciding what to do.
Options include selling your house yourself, voluntarily handing over the deed to your lender, or declaring bankruptcy. Each of these options has disadvantages, but may be better for you than foreclosure.
Can I sell my house before foreclosure?
If you can't afford to keep your home, one way to avoid foreclosure is to sell your house yourself before the foreclosure sale. This is called a preforeclosure sale.
Your lender may agree to delay a foreclosure to give you time to sell your house yourself if:
- you live in your house as your primary residence
- you have a financial hardship and can no longer afford your mortgage payments
- you provide bank statements, proof of income and assets, and any other documents required by your lender
Your lender will specify how much time you have to sell your house before the foreclosure will proceed, and might agree to suspend your mortgage payments during this period. Your lender might even offer you a monetary incentive to sell your house quickly.
If you cannot sell your house for as much as you owe, your lender might agree to a short sale. In a short sale, you sell your house for less than you owe and your lender agrees to accept the sale amount as payment in full. A lender does not have to agree to a short sale, but may agree if the loss is less than the cost of foreclosure.
To get lender approval for a short sale:
- you must sell your house within a specified period of time
- the sales price must be approved by the lender
- if you have a second mortgage or equity loan, those lenders must also agree to the short sale
If you get approval for a short sale:
- make sure your lender agrees in writing to accept the sale amount as payment in full for your debt
- make sure that sales commissions, closing costs, and any other costs related to the sale are paid from the sales proceeds
- make sure you understand all of the terms of your agreement and have a lawyer review all the forms before you sign them
- check with a tax lawyer to make sure you will not have to pay income taxes on the forgiven debt. The IRS usually treats forgiven debt as taxable income. However, the Mortgage Forgiveness Debt Relief Act excludes most forgiven debt related to mortgages from taxable income for the years 2007 through 2012. For details, see Mortgage Forgiveness Debt Relief Act on the IRS web site.
A short sale lowers your credit score, sometimes as much as a foreclosure. However, you can be approved for another home loan sooner with a short sale than with a foreclosure. Under Fannie Mae rules, for example, you can be approved for a home loan two years after a short sale, but not until 5 to 7 years with a foreclosure.
What is a deed in lieu of foreclosure?
If you cannot afford your mortgage payments, your lender may let you voluntarily hand over your house instead of going through a foreclosure. This is called a deed in lieu (DIL) of foreclosure. The lender agrees to cancel your loan in exchange for the deed to your house.
With a deed in lieu of foreclosure, the lender gets title to your house and must sell the house to try to recover the unpaid debt. The lender agrees to forgive any unrecovered debt.
Lenders usually don't want more houses that they have to sell. However, if the alternative is a more costly foreclosure, they might agree to a deed in lieu of foreclosure. If you have a second or third mortgage or an equity loan, those lenders must also agree to the DIL.
If you get approval for a deed in lieu of foreclosure:
- make sure your lender agrees in writing to cancel your entire debt in exchange for the deed and to waive the right to take you to court for a deficiency judgment
- make sure you understand all of the terms of your agreement and have a lawyer review all the forms before you sign them
- make sure you are given enough time to find another place to live before you have to move out of your house
- check with a tax lawyer to make sure you will not have to pay income taxes on the canceled debt. The IRS usually treats canceled debt as taxable income. However, the Mortgage Forgiveness Debt Relief Act excludes most canceled debt related to mortgages from taxable income for the years 2007 through 2012. For details, see Mortgage Forgiveness Debt Relief Act on the IRS web site.
A deed in lieu of foreclosure lowers your credit score, sometimes as much as a foreclosure. However, you can be approved for another home loan sooner with a DIL than with a foreclosure. Under Fannie Mae rules, for example, you can be approved for a home loan four years after a deed in lieu of foreclosure, but not until 5 to 7 years with a foreclosure.
Should I file for bankruptcy?
If you have no other way to avoid foreclosure, you might want to consider filing for bankruptcy. Sometimes bankruptcy can stop a foreclosure and allow you to keep your house. At the least, bankruptcy will postpone a foreclosure for several months.
When you file for bankruptcy, an "automatic stay" goes into effect. The stay, which usually lasts three to four months, stops all debt collection and foreclosure proceedings against you. It gives you time to deal with your financial problems without pressure from creditors. During the stay, it is illegal for any creditors to take action against you unless they get permission from the court.
You should get legal advice before you file for bankruptcy. A legal advisor can help you decide whether to file under Chapter 13 or Chapter 7:
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Chapter 13 bankruptcy allows you to repay your debts over a period of time, usually three to five years, using a court-approved repayment plan. You are allowed to keep your property as long as you follow the payment plan. Chapter 13 does not erase your debts, but may reduce some of them, and gives you extra time to repay them. Chapter 13 is for people who have a regular income and limited debt.
If you are in foreclosure, Chapter 13 allows you to keep your house while you pay back your overdue mortgage payments according to your repayment plan.
Chapter 13 does not change the amount or payment schedule of future mortgage loan payments. To keep your house, you must make all future mortgage payments on time.
For more information, see Chapter 13 Individual Debt Adjustment on the federal government U.S. Courts web site.
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Chapter 7 bankruptcy is a total liquidation bankruptcy. You are allowed to keep certain exempt assets, up to a specified value. All of your non-exempt assets are sold to pay off your creditors. In return, your debts are erased and you get a "fresh start."
You are allowed to file under Chapter 7 only if you do not have enough income to pay off your debts. If your income is greater than the State Median Income (SMI) for your family size, the court will decide if you must work out a repayment plan under Chapter 13 instead.
| Family size |
2009 Massachusetts
State Median Income |
| 1 |
$54,842 |
| 2 |
$66,437 |
| 3 |
$83,104 |
| 4 |
$100,280 |
| each extra |
+ $6,900 |
If you are in foreclosure, Chapter 7 will not prevent your lender from taking your house. However, if the house sells for less than you owe, the remaining mortgage debt will be erased.
For more information, see Chapter 7 Liquidation Under the Bankruptcy Code on the federal government U.S. Courts web site.
Before filing for Chapter 13 or Chapter 7 bankruptcy, you must get credit counseling from an approved agency. Counseling may be by telephone, the Internet, or in person. When you complete the counseling, you will get a credit counseling certificate. If you do not have this certificate when you file for bankruptcy, your bankruptcy case will be dismissed.
For a list of approved credit counseling agencies, see Massachusetts Approved Credit Counseling Agencies on the U.S. Department of Justice web site.
Are there any tax penalties?
The IRS usually treats forgiven or canceled debt as taxable income. A lender who forgives or cancels a debt reports it to the IRS, and the borrower must pay income tax on the forgiven amount. Before 2007, in a short sale, deed in lieu of foreclosure, or foreclosure sale, any debt not recovered by the lender was taxable income to the borrower.
In 2007, Congress passed the Mortgage Forgiveness Debt Relief Act to exclude struggling homeowners from this tax burden. The Debt Relief Act excludes certain forgiven or canceled mortgage debts from taxable income.
To qualify for a tax exclusion under the Mortgage Forgiveness Debt Relief Act:
- the loan must have been used to buy, build, or substantially improve your principal residence, or to refinance a loan used for those purposes
- the loan must have been secured by the residence
- the debt must have been forgiven in calendar years 2007 through 2012
- you must report the amount of forgiven debt on IRS Form 982 and file that form with your federal income tax return
You cannot exclude forgiven debt from a second home, credit card, or car loan under this Act. However, there are other rules that may allow you to exclude these forgiven debts from taxable income. Information is included in the Form 982 instructions.
For more information, see Mortgage Forgiveness Debt Relief Act and Form 982 and Instructions (PDF) on the IRS web site.
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