Voluntary foreclosure is a term used to describe a situation where a borrower who can no longer make mortgage payments chooses to initiate the foreclosure process themselves. Instead of facing an involuntary foreclosure, where the lender takes action due to missed payments, the borrower seeks to take control of the situation. This method may provide a way to avoid further financial strain and potential eviction.
What is Voluntary Foreclosure?
A voluntary foreclosure occurs when the borrower recognizes their inability to continue making payments—often exacerbated by conditions like job loss, divorce, medical bills, or changes in the housing market—and opts to exercise their right to foreclose on the property. This process is commonly referred to as a deed in lieu of foreclosure, where the borrower voluntarily transfers the property's title back to the lender in exchange for cancellation of the mortgage debt.
Important Terms Related to Voluntary Foreclosure
- Strategic Default: This is when a borrower stops making payments on an underwater mortgage with the understanding that default is a more favorable financial option.
- Friendly Foreclosure: Similar to voluntary foreclosure, this term implies the borrower is cooperating with the lender in the foreclosure process.
- Jingle Mail: This informal term describes the act of mailing the property keys back to the lender, signaling the intention to surrender the home.
The Impact of Voluntary Foreclosure
Credit Score Consequences
One of the most significant drawbacks of voluntary foreclosure is the immediate and lasting impact on credit scores. A voluntary foreclosure can cause a substantial drop in a borrower's credit rating, making it more difficult to secure new loans or rental agreements in the years that follow. For example, Fannie Mae mandates a waiting period of four years before one can qualify for a new mortgage after a deed in lieu of foreclosure.
Financial Relief vs. Consequences
Despite the negative consequences, many borrowers find that voluntary foreclosure can actually be less financially debilitating than an involuntary foreclosure. This is due to reduced legal and administrative fees, as well as the potential for acquiring moving assistance from the lender. However, it is crucial to note that borrowers in some states could face deficiency judgments, which means they might still be responsible for paying the remaining balance of their mortgage after the property is sold at auction.
Causes of Voluntary Foreclosure
Many factors can lead borrowers to consider voluntary foreclosure:
- Job Loss: Sudden unemployment can make it challenging to meet mortgage obligations.
- Financial Mismanagement: Many homeowners realize they are living beyond their means and can no longer sustain their mortgage payments.
- Market Conditions: A downturn in housing prices may result in property values falling below mortgage balances.
Alternatives to Voluntary Foreclosure
Before proceeding with voluntary foreclosure, it’s advisable for borrowers to explore other options such as:
- Loan Modifications: Lenders may adjust loan terms to make payments more manageable.
- Short Sales: Selling the home for less than the outstanding mortgage balance may often help borrowers avoid foreclosure impacts.
- Forbearance Agreements: This temporary option allows homeowners to pause or reduce mortgage payments without facing foreclosure.
Pros and Cons of Choosing Voluntary Foreclosure
Pros
- Control: The borrower maintains control over the situation and the timing of the foreclosure process.
- Reduced Complexity: Voluntary foreclosures can simplify the legal procedures compared to involuntary foreclosures, making it quicker to move on from the debt.
- Potential for Assistance: Lenders may offer financial incentives to help with moving costs.
Cons
- Credit Damage: The impact on credit scores lasts for years and can hinder future financial opportunities.
- Emotional Toll: Losing a home can be a significant emotional and psychological strain.
- Future Housing Challenges: Securing a new rental or mortgage may be difficult for a timeframe, impacting living arrangements.
The Housing Crisis and Voluntary Foreclosure
The subprime mortgage crisis of 2007-2009 saw a dramatic increase in voluntary foreclosures. Many homeowners found themselves deeply underwater, with the value of their homes significantly less than the loans taken out against them. The crisis revealed how adoption of risky lending practices led to widespread financial instability, prompting many borrowers to take control of their downward spirals with voluntary foreclosure options.
Conclusion
Voluntary foreclosure is a complex and often difficult situation for borrowers who find themselves unable to make mortgage payments. Despite its deep impact on creditworthiness and potential future financial endeavors, for some, it stands as a viable option to manage unmanageable debt. Before choosing this path, it’s essential for borrowers to explore all alternatives, understand state laws, and consider the long-term implications of such a decision. Consulting with a financial advisor or housing counselor can also provide critical guidance in navigating through this challenging financial landscape.