Voluntary Foreclosure

What Is Voluntary Foreclosure?

A traditional foreclosure begins when a bank or mortgage company decides to foreclose on a property. This is common after a borrower has missed several mortgage payments and is in default.

In the case of voluntary foreclosure, the borrower initiates the process. For example, they've frequently tried and failed to sell the property at a reasonable price, or they know the selling process would take too long. 

As a result, the borrower allows the property to go into foreclosure because they are unable or unwilling to make loan payments any longer. First, however, the lender takes possession of the property from the borrower, just as in traditional foreclosure.

A voluntary foreclosure is also known as:

• Foreclosure with a smile
• Leaving the room
• Mail that jingles (the homeowner puts the keys to the house in an envelope and mails it to the lender)
• Strategic fallback

The first three scenarios typically occur when a homeowner cannot continue making mortgage payments. A strategic default, on the other hand, is distinct. 

It frequently applies to homeowners who can afford to keep their homes and avoid foreclosure but choose not to. 

This strategic decision to stop mortgage payments is frequently made because the home has become a poor investment, and the mortgage has gone underwater.

Reasons Homeowners Choose to Relinquish Property Ownership

In the current intricate real estate market, homeowners might have to make tough choices about their homes. One such choice is whether to start the process of voluntary foreclosure, in which homeowners voluntarily give their lenders possession of their residences.

It is essential for experts in the sector as well as individuals to comprehend the reasons for voluntary foreclosure.

The reasons are:

1. The mortgage is underwater

When a borrower owes more on their mortgage loan than the home is worth, it is called an underwater mortgage. However, this also implies that there is no equity in the house.

This causes a problem for the lender because the home is no longer worth enough to cover the mortgage debt in the event of a default. When a borrower defaults, additional interest and late fees are added to the loan balance, resulting in an underwater mortgage. 

If the homeowner had little equity in the home before the default, these additional expenses could be enough to spin the mortgage upside down.

2. The real estate market has shifted

Changes in the housing market can raise or lower the fair market value of a home. For example, homebuilders may have difficulty obtaining supplies to construct new homes, resulting in a housing shortage. 

Existing home prices will rise if the demand for housing remains constant. In other words, the fair market value of the existing home rises.

On the other hand, changes in the housing market can cause home prices to fall. For example, if interest rates rise, it will be more difficult for prospective home buyers to obtain mortgages. In addition, the loan amount may be reduced if approved, limiting the number of houses they can afford.

If the economy suffers a downturn, home values may fall as well. Economic downturns frequently increase foreclosures. It's bad enough that foreclosed homes tend to depress the values of nearby properties. 

However, it creates an additional supply of houses, which can reduce the value of existing homes even further.

3. The homeowners' financial situation has changed

A lender will examine a homeowner's finances to ensure they can make monthly mortgage payments if approved for a mortgage. However, the homeowner's finances can change throughout the mortgage.

This could result from job loss, income reduction, increased expenses, or other financial hardships. In such situations, the homeowner may choose to surrender the property to avoid further financial strain.

The consequences of voluntary foreclosure

A voluntary foreclosure will have a significant negative impact on the borrower's credit. This will make obtaining other loans, credit cards, and other forms of credit more difficult. 

Foreclosures can have an impact on a borrower's ability to find work. Therefore, a voluntary foreclosure is preferable to an involuntary foreclosure. Choosing a voluntary foreclosure will, at the very least, mitigate the damage.

The American Real Estate Bubble

Voluntary foreclosures are also known as friendly foreclosures, mortgage releases, walking away, and strategic defaults. During the Great Recession, voluntary foreclosures became popular.

Borrowers struggled to make mortgage payments during the American housing bubble and subprime mortgages. As a result, they borrowed beyond their means, and the recession left many unemployed, adding to the financial strain caused by mortgage payments. 

On top of that, housing prices have plummeted, and many mortgages have gone underwater, meaning that the amount owed exceeds the home. Before the housing bubble in America, voluntary foreclosures were uncommon, and the term itself was rarely heard.

At the end of the 2000s, voluntary foreclosures became common. However, the American housing bubble had such a large impact that voluntary foreclosures are still common today. As a result, some borrowers' home values remain lower than the amount owed on their mortgage.

Ways to avoid Voluntary foreclosure

For homeowners, facing foreclosure can be a frightening thought, but voluntary property surrender is not the only option.

For those looking to manage financial difficulties while maintaining their home equity and creditworthiness, it is essential to comprehend these options and their ramifications.

The three main methods to prevent voluntary foreclosure and lessen its effects on homeowners are discussed below:

1. Deed in Lieu of Foreclosure

A deed in lieu agreement is an arrangement in which you give the deed for your home to your mortgage lender. To avoid foreclosure, homeowners enter into a deed in lieu agreement.

Foreclosures appear on your credit report, making it nearly impossible to buy another home for years. A deed in lieu of foreclosure can relieve you of your mortgage obligations while avoiding a foreclosure on your credit report.

The lender's lien on the property is released when you hand over the deed. This allows the lender to recoup some of its losses without forcing you to file for bankruptcy. 

When you turn over your deed, the lender releases you from any remaining mortgage debt. Unfortunately, many homeowners seek deeds instead of foreclosure when their mortgage becomes underwater, meaning they owe more on their home than it is worth.

Advantages of a Deed in Lieu

The advantages of a deed in lieu are:

1. Minimization of your shortcoming: A "deficiency" is the difference between what you owe and what your home is worth. If you owe more on your home than it is worth, a deed in lieu can eliminate your deficiency. 
   In exchange for voluntarily giving the lender your deed and keeping the house in good condition, your lender may agree to forgive or significantly reduce your deficiency.
2. Possibility of moving assistance: Lenders prefer to take control of your property when it is in the best possible condition. Many lenders offer "cash for keys" agreements to assist you in finding a new place to live if you forfeit your deed without causing any damage to your home.
3. Less credit damage: It stays on your credit report for four years, whereas a foreclosure stays for seven. Using a deed instead of foreclosure can allow you to purchase a new home sooner than if you went through foreclosure.

Disadvantages of a Deed in Lieu

The disadvantages of a deed in lieu are:

1. Home loss: When you accept a deed in lieu of foreclosure, your lender removes your name from the title of your residence. This agreement is not for you if you still want to live in your residence.
2. No guarantee of acceptance: Your lender is not required to accept a deed in lieu of foreclosure. They have the option to reject your proposal.
3. Your credit will still suffer: While a deed-in-lieu arrangement will not harm your credit as severely as a foreclosure, your credit score will still suffer. You will also find it difficult to obtain another mortgage if you have a deed-in-lieu on your credit report.
4. You might owe taxes on the forgiven loan balance: If your lender forgives more than $600 of your loan's deficiency, the IRS considers it income. Therefore, you must pay income tax on any deficiency forgiven by your lender when you pay taxes.

2. Loan Modification

A loan modification may be appropriate if you cannot make your mortgage payments but wish to remain in your home. A loan modification occurs when your lender adjusts your loan's interest rate to reflect current market rates.

You may owe more money on your home than it is valuable. Your lender may be able to set up the additional principal in a forbearance account in that case. The excess principal does not accrue interest while in forbearance. 

This can help you avoid further debt while you pay off what you owe. The amount in forbearance is due when the remainder of the loan is paid off.

A lender, like a deed in lieu agreement, is under no obligation to modify your loan. Instead, work with your lender to find a solution that benefits both of you.

3. Short Sale

If you cannot obtain a modification or do not wish to continue living in your home, you may be able to sell it through a short sale. A short sale occurs when you sell your home for less than the amount owed on your mortgage.

Most short sales occur because property values in your area have declined. During a short sale, you communicate with buyers, show your home, and speak with real estate agents just as you would in a regular sale.

However, unlike a regular sale, your lender must approve the short sale before it can be completed.

After a short sale, you may or may not still owe money. In addition, some states (such as California) have laws prohibiting deficiencies following a short sale. 

If you have a deficiency, your lender may sue you to obtain a deficiency judgment. If you cannot pay the difference between what is left on your loan and the price of your home, ask your lender to waive their right to sue for deficiency.

advantages of purchasing a foreclosed home

Foreclosed homes present several potential advantages for buyers willing to navigate the complexities of the foreclosure market.

Here are some key benefits:

1. Price cutbacks

Foreclosed homes almost always cost less than other properties in the neighborhood or are listed below market value, which is a major benefit. This is because the lender wants to get the house off their books.

2. Standard loan arrangements

When purchasing a foreclosure, you may have to follow a slightly different bidding and purchasing process, but you still have a few loan options as long as it is not a cash-only auction.

You can buy a home with a conventional loan, government-backed VA loan, FHA loan, or USDA loan as long as it is in livable condition.

Government-backed loans can make homeownership more affordable; however, the government may require repairs if the property is damaged.

Disadvantages of Purchasing a Foreclosed Home

While purchasing a foreclosed home can offer compelling advantages, it's essential to consider the potential drawbacks before making a decision.

Here are some disadvantages to be aware of:

1. Increased maintenance concerns

Some homeowners have no incentive to keep their homes in good condition when they know they will lose their homes to foreclosure. 

If something shatters, the house owner is unwilling to spend money repairing it, and the issue may deteriorate over time. When you purchase a foreclosed home, you are responsible for fixing any existing problems.

2. Sales as-is

The lender's primary concern is recouping their money as soon as possible, which almost always means an as-is sale. If you don't have significant money to invest in repairs, you shouldn't buy a foreclosed home.

3. Rights of squatters

A house may be legally foreclosed, but that doesn't mean no one lives there. Many foreclosed homes sit vacant for months or years, attracting squatters. 

If you purchase a home with a squatter living in it, you must legally evict them, even if the person or people in question have no claim to the property. This process can take months and cost thousands of dollars in legal fees.

Conclusion

Foreclosures can be either voluntary or involuntary, and navigating the complexity of them can be difficult for both homeowners and prospective buyers. Making wise selections in these situations requires investigating your options and comprehending the ramifications.

Homeowners who are struggling financially may choose to file for voluntary foreclosure as an alternative to forced foreclosure, although doing so has drawbacks of its own.

Even if it might ease financial strains right now, it might have long-term effects on creditworthiness and future financial security.

Examining options other than voluntary foreclosure, like loan modifications, deed in lieu agreements, or short sales, gives homeowners the chance to reduce losses and protect equity in their homes.

Every choice has pros and cons of its own, so it's important to weigh them all carefully and consult financial experts. 

There are possible benefits for purchasers who are interested in buying foreclosed houses, including access to regular lending arrangements and cheaper rates.

Buyers should be aware of the higher maintenance requirements, as-is sales terms, and possible legal ramifications that come with purchasing a foreclosed property, though.

Ultimately, careful planning, persistent study, and expert advice are necessary for navigating these complicated real estate transactions, regardless of whether you are contemplating buying a foreclosed property or are in the process of facing foreclosure.

People can make decisions that are in line with their financial objectives and circumstances by considering all of the options and assessing the benefits and drawbacks.

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