When you default on a loan or sell a house for less than the borrowed amount, several consequences can occur:
When you default on a loan, it's important to understand the series of events that will unfold. The first sign of trouble is often late fees. As soon as a payment becomes overdue, most lenders will hit you with late fees, adding to your financial burden and making it even more challenging to catch up. Alongside these penalties, the impact on your credit score is swift and severe. Missed payments get reported to credit bureaus, tarnishing your credit profile and making future borrowing more expensive and difficult.
As the days turn into weeks and months, you'll start receiving notices and escalation letters from your lender, usually at 30, 60, and 90-day intervals of missed payments. Ignoring these is not advisable, as they set the stage for what's next: the lender may officially declare you in default if payments remain overdue beyond three months. This is where things get serious. The lender now has the option to pursue legal action to reclaim the outstanding amount, which could include court fees and additional costs.
And in the most severe cases, if the loan is secured by property, the dreaded foreclosure process could begin. Your property is at risk of being repossessed and sold to recover the lender's funds.
Selling a house when you're underwater on your mortgage presents its own set of challenges. One option is a short sale, where the lender agrees to accept less than the full amount owed. However, this requires lender approval and may lead to forgiveness of the remaining debt. Be aware, though, that there could be tax consequences on the forgiven amount, as it might be considered taxable income.
Alternatively, you might choose to pay the difference out of pocket, selling the house and covering the shortfall yourself. For those unable or unwilling to do so, a deed in lieu of foreclosure is another route; this involves transferring the property title to the lender to satisfy the debt, potentially avoiding the foreclosure process altogether. However, lenders can still pursue a deficiency judgment, seeking the remaining balance even after the house is sold.
Both defaulting on loans and selling a house short have significant implications. Your credit score will take a hit, which can affect everything from your ability to get a credit card to the interest rates on future loans. The tax implications should not be underestimated either, as any forgiven debt might be treated as taxable income. Furthermore, your past financial troubles could make future borrowing challenging, with fewer lenders willing to take a risk on your ability to repay. Lastly, the potential for legal ramifications remains, as lenders have every right to pursue recovery of their money through the courts if necessary.
The key takeaway is to communicate with your lender as soon as you foresee any trouble. They might have options available to help you stave off default or foreclosure, such as loan modifications or temporary forbearance.