Property is not just an asset, but it is also the biggest security available to you. A mortgage is a loan from a bank or any Non-banking financial institution that helps the borrower purchase a house. The loan is secured by the home itself, so if the borrower defaults on the loan, the bank can sell the home and recover its losses.
Mortgage loans are among some of the costliest loans given its long-term liability. There may be times when you fall short on your payments or overestimated your future income. When you reach the point where your monthly payments are just too much to handle, foreclosure becomes a very real possibility. Defaulting on a mortgage is one way out of the situation, but it comes with high risks you must consider.
What is considered a default?
The most common way of defaulting on your loan is by not making the required monthly payments and falling behind. But defaulting doesn’t just include missing payments— breaching other terms in the loan contract is considered defaulting as well. For instance, you’ll likely be in default if:
You don’t pay the property taxes
You don’t pay your property insurance
You transfer the titles to the property to a new owner without getting the lender’s permission.
Consequences of Default
The bank would not foreclose the loan immediately if you defaulted on one EMI. In fact, foreclosure is always the last option which banks resort to. But if you continue to default on your EMI payments for more than 3 months, then there is a high possibility that your lender will begin the foreclosure process.
Typically, banks have their method for recovering losses. They will send you a demand notice, asking you to pay your dues as soon as possible, after three months of consequently missing your EMI payments. If you don’t respond to any of the mails, the bank sends a legal notice through its legal department. You won’t immediately lose your property as the bank waits for three months before declaring an asset a non-performing one. After the end of the three-month period, the bank can officially term the home loan an NPA (non-performing asset) and start the process of recovering the property by enforcing the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, (SARFAESI). Even after invoking the SARFAESI Act, the bank gives the borrower a 2-month period to repay the dues.
If you don’t respond to any of the notices, the bank, after five months from the first default, sends a notice, stating that it has valued the property for a certain amount and that it will auction the property on a certain date. (usually a month from the date that the bank sends you the auction notice).
One thing to note is that no lender wants to go through such a cumbersome process. If you find yourself unable to make the payments, talk to your lender about your options. Most banks would be willing to give leeway, given your circumstances are genuine, like the loss of a job and permanent total/partial disability. You can approach your lender when you receive the non-payment notice and try to settle the things out with the bank. You can try to negotiate a settlement or payment arrangement of some sort to avoid a lawsuit, but if that doesn’t work, unfortunately, you’ll have to go to court.
If it seems that your financial situation may not improve even after six months, a better alternative would be to sell the property and pay off the loan completely. You can talk to your lender about selling your property and using the sale proceeds to repay the loan. However, you must ensure that you continue paying the EMIs while the sale negotiations are on. This proves to your lender that you are serious about repaying your loan and will ensure that your credit score doesn’t dip.
If the reason behind your missed EMIs is the rise in interest rates, you can explain the reason and request your lender to restructure the loan. Banks will often agree to restructure the loan and increase your loan tenure so the EMI amount remains the same for you and you can easily manage within your budget.
If your lender is not ready to restructure the loan, then you can consider refinancing your loan. But in this case, it is important to calculate the exact expenses you will incur in terms of processing charges and other rates.
Last but not the least, if nothing works out then you may consider selling off your investments like gold, mutual funds, and emergency funds to help pay your EMIs and ease out your burden.
Cost to your credit score
The main reason you need to start paying the EMI again, other than avoiding foreclosure, is to ensure that your credit score is not negatively impacted. If you go into default, your credit score will certainly plummet. Payment history accounts for about 30 percent of your credit score and anytime there’s a delay or default on a payment, it knocks off a few points. If your home ends up being foreclosed on, well, you can pretty much guarantee that your credit score will plummet. Foreclosures can stay on your credit for up to seven years, making it difficult to get loans or credit cards in the future.
If you find yourself unable to pay your loans and are considering walking away from your home after exhausting all your sources of funding, you may file for bankruptcy under the Insolvency and Bankruptcy Code (IBC). It is important to note that bankruptcy can and will cause your credit score to drop dangerously. Also, note that the process is not very streamlined.
The bottom line
Before going for any type of loan, be very sure that your finances are in line. Plan for all kinds of contingencies and keep a decent emergency fund available always with you. Most lenders want to avoid getting into legal hassles and thus if you discuss your situation with your lenders and clarify your financial situation, then there are good chances that your lender will give you some solution that is agreeable to everyone involved.