This is a valid concern, and she’s wise to consider how to allocate her resources to protect herself against losing her house.  Being upside-down (owing more on a house than it would sell for) is not a problem by itself, as long as the payments can be made.  Being upside-down becomes a problem is when the borrower wants to refinance, or if the borrower runs into financial trouble and goes into default on the mortgage.

So, assuming there’s no immediate worry, what are some choices for preparing for this situation?

• Pay down the mortgage. This means paying extra principal each month.  The mortgage balance goes down more quickly, and fewer payments need to be made over the course of the loan.  The minimum payment doesn’t change (in her case, GBP 500 per month).
• Make some prepayments. This would mean paying, for example, GPB 1500 for February, March, and April, while continuing her GPB 500 per month payments.  This way, she could stop paying her mortgage for three months and still be current.
• Invest more or save more. This is setting aside a “job loss emergency fund” that can be drawn down to cover mortgage payments and other current expenses.

So, which would be appropriate?  If the concern is not being able to make mortgage payments within, say, the next few years, then paying down the mortgage (first option) probably would not alleviate these concerns.  It depletes her reserves, but does not bring relief from making payments.

The other two options will allow her to have a cushion if her income drops.  If she’s more concerned about dipping into the reserves prematurely, then it may be wiser to make a few prepayments.  If she can leave the money alone, saving cash is better, because she can earn interest on the money.

(Note:  Thanks to Taking Charge for including this post in the Carnival of Personal Finance!)

The more equity you have in your home, the less eager your lender may be to work with you. It’s an ironic fallout of the foreclosure crisis that those who have been the most diligent about making payments and have lived in their homes the longest are most at risk. Simply put, the lender can take what you’ve already paid in equity, sell the home for less than it’s worth and still make money.

When lenders work with borrowers to put off foreclosure, it’s all about themselves, not the borrowers.  The lenders have a business reason for working with a borrower who’s upside-down and falling behind on their payments.  Foreclosure and repossession are expensive prospects, and taking less money in now in order to keep the payments coming back is far better selling a property at a loss, and paying foreclosure costs, or even worse, going through the foreclosure process and not finding another buyer.

If the borrower is not upside-down, but instead has equity the asset, it’s very little risk for the lender just to take it back and sell it.  A loan balance equal to half of the house’s value is far less risky for the lender — and far riskier for the borrower — than a fresh loan with a low down payment, or one that was written a couple of years ago when housing prices were at their highest.

This is unfortunate.  If you’re in a position with a fair bit of equity in your home, guard your income streams zealously, and do everything you can to keep your mortgage payments going out on time.  It’s just not worth your lender’s time to work that hard with you.

The piece also suggests that this undermines the value of mortgage-backed securities, and raises the costs to new borrowers since banks can be made to hold onto non-performing assets.

Forcing the banks to keep the notes and accept lower rates of return doesn’t seem really to be the worst that could happen to these banks, though.  It’s rarely a good time for banks to foreclose, but now it’s especially bad.  These homes will be vacant and will be thrown onto a market that already has too much inventory.  It seems much better instead to hold onto the notes for up to four more years, get some more payments from the homeowner who now has some more hope that things will turn around, post any late fees that the homeowner might have incurred and might continue to incur, sit out the slump (which may turn around in the meantime) and then be able to foreclose in more of a seller’s market.

In short, this legislation helps the banks more than it hurts them, if for no other reason than the legislation’s timing.

What do you think? Am I missing something big?

• Use your assets. “Do you have assets-a second car, jewelry, a whole life insurance policy-that you can sell for cash to help reinstate your loan? Can anyone in your household get an extra job to bring in additional income? Even if these efforts don’t significantly increase your available cash or your income, they demonstrate to your lender that you are willing to make sacrifices to keep your home.” This can be good advice if the setback that’s gotten the homeowner into hot water is temporary — that is, there’s a light at the end of the tunnel. People will go to great lengths to keep their homes. The flip side of this is that the lenders, unfortunately perhaps, are more willing to deal with you if you’re upside-down on your mortgage because they will take a really big loss if they end up foreclosing. If you have equity, staying on the defensive and paying however you can is the best way to go because you stand to lose more, because the lender is probably a bit more likely to foreclose if they have a cushion.
• Avoid foreclosure prevention companies. “You don’t need to pay fees for foreclosure prevention help-use that money to pay the mortgage instead.” Just like companies are beginning to see the market in helping people to walk away from their homes, companies are also well aware of the market to take some of the scare factor away from dealing with a lender and charging for things that could be done for free.
• Watch out for foreclosure recovery scams! “If any firm claims they can stop your foreclosure immediately if you sign a document appointing them to act on your behalf, you may well be signing over the title to your property and becoming a renter in your own home! Never sign a legal document without reading and understanding all the terms and getting professional advice from an attorney.” If it sounds too good to be true, well then it probably is! Facing foreclosure is disheartening and likely makes people feel more vulnerable and more willing to consider offers that would be disadvantageous under more normal circumstances.

My comments on the other tips are here and here.

A neighbor who’s in financial trouble probably is worried about their house, but it’s almost certain that they’re not worried about the value of your house going down.  The value of your house will go down in the event of a foreclosure though.

On first reading Weston’s article I laughed at her suggestions, but she’s absolutely right.  No one will care about your finances as much as you will. If this means sticking your nose in their business a little bit, then that’s what has to be done for both your good and their’s.  Here’s what she suggests:

• Suggest that they get help. If they’re in denial about the foreclosure, then this is crucial.  Nothing good happens until one gets past this point.
• Enlist your HOA to use the power of numbers as leverage.
• Be aware of who’s moving in or out and especially be aware of signs that the property is becoming abandoned.
• Trespass to mow the lawn?! I think this one’s going a bit far.  If there’s a way to get the owner’s permission to do this, though, that might help.
• Push for legislation to allow judges to lower the amount owed on houses?! This is a can of worms, and opens the door for other abuses.  Lenders can already lower the amount owed on their own accord if they want to, but forcing them to take less for the property through a judgment is the start of a slippery slope.

One I’d add: See if you can buy the property! This isn’t for everyone, but managing a property next door does have its advantages.  Plus, it’s a neighborhood you know well and would like to keep attractive.

• Know your mortgage rights. “Find your loan documents and read them so you know what your lender may do if you can’t make your payments.  Learn about the foreclosure laws and timeframes in your state (as every state is different) by contacting the State Government Housing Office.”  Knowing how much time lenders need to wait, or have to act, helps.
• Understand foreclosure prevention options. “Valuable information about foreclosure prevention options can be found here.”  Now that lenders stand to lose a lot more through the foreclosure process than they did when house prices were appreciating rapidly, they will be more willing to work with you as long as you continue to make payments.
• Contact a HUD-approved housing counselor. The government offers free or low-cost housing counseling nationwide, including representation in negotiations with lenders and general financial organization.  Numbers to call are (800) 569-4287 or TTY (800) 877-8339.
• Prioritize your spending. Keeping your house should be the top priority aside from staying healthy and taking care of medical conditions.  Everything else is in the weeds, especially “nice-to-haves” like extended cable, NetFlix, etc.  Even unsecured debt is lower on the totem pole.  Missing a credit card payment isn’t good of course, but missing a mortgage payment is worse.

I’ll discuss the last three in a few days, but if you want them all, you can go here.

• Don’t ignore the problem. “The further behind you become, the harder it will be to reinstate your loan and the more likely that you will lose your house,” the site goes on to say. Regardless of what the problem is — health problems, alcoholism, addiction, or financial problems — it’s human nature to be in a state of denial about what’s happening. Realizing that the foreclosure is likely, and then dealing with the issues involved, may get things back on track. The earlier, the better.
• Contact your lender as soon as you realize that you have a problem. “Lenders do not want your house. They have options to help borrowers through difficult financial times.” With more and more mortgages becoming upside-down — meaning that more is owed on the house than what it would likely sell for — lenders really don’t want your house if there’s the possibility that they’d lose money on it. New legislation, for better or worse, is in process for them to receive funds to help homeowners keep their houses out of foreclosure. Again, the earlier, the better.
• Open and respond to all mail from your lender. “The first notices you receive will offer good information about foreclosure prevention options that can help you weather financial problems. Later mail may include important notice of pending legal action.”  The news from your lender won’t get any better if you stop paying them.  This gets back to the top tip on the list:  Don’t ignore the problem!  Just because the mail is unopened doesn’t mean that there isn’t a problem.

I’ll do a couple more posts adding to the HUD’s great tips, but if you want more right now, check them all here.