A good place to start is by understanding the position of the lender. A game plan for survival should be based on a realistic view of what the lender is likely to be willing to do.

When a borrower is unable to pay but the problem is temporary, the lender has an interest in finding a way to help the borrower ride it out. A tool for this purpose is a forbearance agreement combined with a repayment plan.

A forbearance agreement means that the lender suspends and/or reduces payments for a period, usually less than 6 months, although it can go longer. At the end of the period, the repayment plan kicks in. The borrower agrees to make the regular payment plus an additional agreed-upon amount that will cover all the payments that were not made during the forbearance period. The repayment period is usually no longer than a year.

When successful, the borrower is brought current after a lapse, and the lender suffers no loss. However, a lender will only consider this approach if convinced that the borrower's problem is temporary. The burden of proof is on the borrower.

If the borrower's problem is not temporary, the lender's objective is to minimize loss. The ultimate remedy is foreclosure, where the lender goes through a lengthy legal process to acquire possession of the house. The lender then sells the house to recover the loan balance, unpaid interest and expenses -- provided there is sufficient equity in the property to cover it all.

Lenders often do not come out whole on a foreclosure, and they do not like forcing people out of their homes. They look for alternatives to foreclosure that will cost them less, but they don't want to be scammed by borrowers in the process.

If a borrower's income has been reduced to the point where she can't pay the current mortgage but could pay a smaller amount, the lender might consider a loan modification. This could be a lower interest rate, longer term, a different loan type, or any combination of these. Unpaid interest may be added to the loan balance.

A lender is likely to be most receptive to a loan modification where the borrower has little equity in the house, but wants to keep living there. With no equity, foreclosure would be costly. But the lender must be convinced that the borrower's inability to pay is completely involuntary.

If the borrower's inability to pay is long-term and the borrower is resigned to giving up the house, the lender will consider several alternatives to foreclosure. If the borrower has a qualified purchaser who will take title in exchange for assuming the mortgage, the lender may allow it. This is called a workout assumption.

Alternatively, the lender might allow the borrower to put the house on the market and accept the sale proceeds as full repayment, even though it is less than the loan balance. This is called a short sale.

If the borrower is unable to sell the house, the lender might accept title to the house in exchange for discharge of the debt. This is called a deed-in-lieu of foreclosure.

Knowing what a lender can do is useful, but it does not tell you what a particular lender WILLdo in any specific situation. Lenders differ in how they respond to payment problems. It may depend on whether they own the loan or merely service it. It may also depend on who takes your call.

I have always advised borrowers having payment problems to approach the lender before they become delinquent. Some have written back, however, to say that their lender won't talk to them until after they become delinquent. This is a way that some lenders keep their servicing costs down. The impact on the borrower's credit rating is not a consideration. It means that the borrower in trouble may have to press his case further up the corporate ladder.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

Copyright 2003 Jack Guttentag