Loss Migation
What Is the Definition of Loss Migation?
Loss mitigation is the process by which a bank tries to minimize its loss in a loan the borrower isn't repaying according to terms. In real estate, this applies mostly to the bank working with homeowners who have been unable to make their mortgage payments. In a nutshell, this means the bank isn't receiving the return on its investment that it needs to make the loan profitable. So, third-party loss mitigation negotiators work with the bank and the homeowner to find a solution or liquidate assets for the smallest possible loss of money.
Understanding Mortgage Default
As mentioned, homeowners not paying their mortgages timely prompts the loss mitigation process. Typically a person has a 10- to 30-year mortgage and makes monthly payments based on their income, but loss of a job, demotion, illness or other unforeseen circumstance can cause a person to fall behind. Most often when mortgage payments have not been received in full for several months, the bank begins foreclosure proceedings. The longer the bank holds on to a delinquent loan, the more money the bank loses.
What is Loss Mitigation Negotiation?
Once the bank files a lawsuit to begin the foreclosure proceedings, experienced negotiators will typically then come in as a third party to work with both parties to mitigate the loss in a way that both parties can agree upon. Often this involves determining a fair market value for the home, which is typically going to be less than the debt owed. The delinquent borrower may also try to come up with the funds or find a way to keep the property. Because each situation varies with the circumstances of the home owner, skilled negotiators are needed to address all concerns.
What Are the Most Common Types of Loss Mitigation?
Throughout the loss mitigation procedure, the negotiator can put forth many different types of solutions for the borrower and lender to agree upon. Probably most commonly known, a short sale often takes place where the lender will agree and settle on the sale and lump sum of a smaller amount than the debt owed. The negotiator may also help both parties adjust the terms of the loan through a loan modification process that typically either lowers the interest rate or extends the loan's time period for lower monthly mortgage payments. The homeowner may also try to refinance the mortgage with another lender.
Other Types of Loss Mitigation
Other loss mitigation solutions that are less common include: giving the bank collateral to be released from the mortgage obligations, the bank paying the homeowner to vacate the property quickly without damaging it, entering into a forbearance agreement by which no mortgage payments are needed for a set time period to get back on track, or using governmental assistance programs through the U.S. Department of Housing and Urban Development (HUD).
Foreclosure Abandonment Laws
Mortgaged homeowners who are struggling with their mortgage payments may decide to abandon their home to the bank. Known as foreclosure abandonment, the action involves walking away from the home before the lender legally forecloses it through a foreclosure sale. Abandonment is risky, as the lender may not foreclose on the home, leaving the homeowner liable for the mortgage payment, utility bills and other expenses related to the property even though he no longer lives there.
Foreclosure Abandonment Basics
Homeowners who owe more on their mortgage than their home is worth sometimes cannot sell their home or renegotiate or modify the terms of their mortgage. In this scenario, homeowners in financial difficulty may choose to avoid the financial loss of paying down a mortgage that exceeds their home value by simply abandoning the home and allowing the bank to foreclose. Foreclosure abandonment is sometimes called strategic default because it's a choice to default that is motivated by financial strategy rather than the inability to pay.
Risks for the Homeowner
Under the mortgage contract, the borrower agrees to pay back the loan with interest and offers the deed of his house as collateral to secure the loan. A lender may pursue in court any homeowner who fails to uphold his end of the bargain. The homeowner is also responsible for all expenses related to the property including taxes, insurance and utilities. Regardless of whether the homeowner lives at the property, he is still responsible for the mortgage costs and the property expenses until the new property owner or the bank gets back the title at a foreclosure sale. If the bank chooses not to foreclose, the borrower may be on the hook for significant expenses related to a property that he believes he has abandoned.
Borrower Protection
State laws often establish additional rules for foreclosure abandonment. In some states, like California and Arizona, it is legal for a homeowner to abandon a foreclosure without recourse or the threat of their lender pursuing them for the entirety of their loan. These state laws protect homeowners from some of the potential legal consequences of abandonment. This doesn't mean, though, that a strategic default is without consequences even in these non-recourse states. Defaulting homeowners will still take a huge hit on their credit rating and may find themselves denied for future loans.
Tax Law Consequences
Other regulations governing foreclosure abandonment are tax-related. In some cases, there are serious tax consequences to abandoning a home loan obligation. The IRS considers an abandoned debt obligation that exceeds home value to be a type of income. In other words, if the abandonment and subsequent foreclosure result in some or all of the outstanding debt being written off, you pay income tax on the forgiven amount in some cases. Note that this rule usually does not apply in the case of non-recourse loans, according to the IRS.