Can You Refinance a Mortgage That’s In Default?

Falling behind on mortgage payments can be incredibly stressful. When your mortgage goes into default, you might wonder if refinancing is still an option to help get back on track. The short answer is: it’s possible, but complicated. Let’s explore the realities of refinancing a defaulted mortgage and what alternatives might be available.

Understanding Mortgage Default

First, it’s important to understand what “default” means. A mortgage is typically considered in default when you’ve missed payments for a specific period (usually 90+ days), triggering the pre-foreclosure process. At this point, your lender has likely reported the delinquency to credit bureaus, significantly impacting your credit score.

Can You Refinance While in Default?

The Challenges:

1. Credit Score Impact: Default severely damages your credit score, often dropping it below the minimum requirements for most refinancing options.
2. Lender Reluctance: Traditional lenders are unlikely to approve refinancing for a loan already in default since it demonstrates high risk.
3. Equity Considerations: If your home’s value has decreased or you have little equity, refinancing becomes even more difficult.
4. Qualification Hurdles: Meeting debt-to-income requirements becomes harder if your financial situation has worsened since your original mortgage.

Potential Refinancing Options for Defaulted Mortgages

Despite these challenges, some possibilities exist:

1. FHA Streamline Refinance

If your current mortgage is an FHA loan, you might qualify for an FHA Streamline Refinance even with a history of late payments. However, you typically need to have made at least three consecutive on-time payments after falling behind.

2. VA Interest Rate Reduction Refinance Loan (IRRRL)

For VA loan holders, the IRRRL program sometimes accepts applications from borrowers who have recovered from default but may still have less-than-perfect credit.

3. Portfolio Lenders

Some portfolio lenders (who keep loans on their books rather than selling them) may offer refinancing options for borrowers in default, though interest rates and terms will be less favorable.

4. Specialized “Rescue” Refinancing

A small number of lenders specialize in high-risk refinancing for borrowers in default, but these often come with extremely high interest rates and fees.

Better Alternatives to Consider

In many cases, alternatives to refinancing may be more realistic and beneficial:

1. Loan Modification

Contact your current lender about a loan modification, which changes the terms of your existing mortgage to make payments more manageable. Many lenders prefer this to foreclosure.

2. Repayment Plan

Your lender might allow you to spread the missed payments over several months while continuing to make regular payments.

3. Forbearance

Temporary forbearance allows you to pause or reduce payments during financial hardship, though the missed amounts will need to be repaid later.

4. Housing Counseling

HUD-approved housing counselors provide free guidance on avoiding foreclosure and can help negotiate with your lender.

5. Selling the Home

If you have sufficient equity, selling the home before foreclosure might be the best financial decision in some situations.

Steps to Take When Your Mortgage is in Default

1. Don’t avoid communication: Respond to your lender’s calls and letters immediately.
2. Gather financial documentation: Prepare recent pay stubs, bank statements, tax returns, and a hardship letter explaining your situation.
3. Contact a HUD-approved housing counselor: These professionals provide free assistance and can help explore all available options.
4. Be wary of scams: Avoid companies promising guaranteed mortgage rescue for upfront fees.
5. Act quickly: The longer you wait, the fewer options you’ll have.

The Bottom Line

While refinancing a mortgage in default is technically possible, it’s rarely the most accessible or beneficial solution. Most borrowers will find better outcomes through loan modifications, repayment plans, or other foreclosure alternatives offered by their current lender.

If you’re facing mortgage default, the most important step is to be proactive. Contact your lender immediately, seek professional guidance, and thoroughly explore all options before making decisions that will affect your financial future and homeownership.

Remember that specific programs and options vary by state and individual circumstances, so professional guidance tailored to your situation is invaluable.