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Lenders offer solutions to keeping your home during tough times

For homeowners, it is the ultimate nightmare: You lose a job or fall seriously ill. You no longer have the money needed to pay the monthly mortgage. Your lender contacts you, asks what's going on and demands that you pay up, pronto.

Suddenly, you are on the icy downward slide to default, foreclosure and total loss of your home, your equity and your credit standing. Thousands of American homeowners experience this nightmare every year, but a new, groundbreaking study documents an important countertrend: Well over half of all homeowners who fall behind on payments on loans owned or insured by the three largest players in the mortgage market are now being offered financial rescue plans designed to save them from the horrors of foreclosure.

The study, co-authored by professor Richard Green of George Washington University and Amy Cutts Crews, deputy chief economist for mortgage giant Freddie Mac, examines the extent and effectiveness of these mortgage lifesaver plans, known in the industry as "loss-mitigation" techniques. The good news: They are more frequently offered to borrowers in trouble than ever before. And they really work.

Barely a decade ago, according to the study, most homeowners who missed two or more payments on their loans were treated as goners, heading for the inevitable foreclosure of their homes. Only a small percentage of them were contacted by their lenders or loan servicers with offers of alternative, home-saving courses of action.

Today, by contrast, more than half of all seriously delinquent borrowers with loans owned or insured by the biggest mortgage players — Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA) — are contacted, evaluated and offered repayment or "workout" options. Even more significant: Borrowers who agree to enter a formal repayment plan are 80 percent less likely to lose their homes than those who do not. Even among lower-income borrowers, who have a tougher time pulling out of financial crises, 68 percent of repayment plan participants save their homes.

The rescue plans

What are these rescue plans, and why are lenders now offering them so widely? The study identifies five primary alternatives:

Partial reinstatements: Let's say you miss two or three monthly payments because of an unexpected, short-term income loss. The lender agrees to a plan whereby you resume your regular monthly payments, and pay off the amounts you missed in mutually agreeable chunks over a period of time, such as one year. All moves toward foreclosure are canceled by the lender.

Short-term forbearance: This allows for the suspension of up to three payments, or a reduction in payments due for up to six months, in order to help you get back on your feet. After the forbearance period is up, you agree to a stretched-out repayment plan covering all the payments you missed.

Long-term forbearance: It's the same idea as short-term forbearance, but deals with more serious delinquencies and allows suspension or reduction of payments for between four and 12 months.

Loan modifications: These involve permanent, contractual changes in one or more terms of the mortgage itself. For instance, the lender might agree to a lengthening of the loan payoff period, or a reduction in the interest rate on the note. The financial institution recognizes that you are committed — and able — to avoid foreclosure with the help of modest changes in the structure of the original mortgage.

Partial claims: In certain cases, the FHA "advances" — pays — the arrears owed by delinquent borrowers to bring the loan account current. In exchange, the borrowers sign a promissory note secured by the property to repay the FHA that money when they sell the house or pay off the mortgage.

Foreclosure is costly

Why are Fannie, Freddie and FHA, working through the thousands of lenders who originate and service mortgages for them, now making such energetic use of foreclosure alternatives for troubled homeowners? Part of the reason, no doubt, is a genuine desire to help customers avoid the personal tragedies associated with foreclosure. But enlightened self-interest also is at work.

According to the study by Green and Crews, loans that go to foreclosure cost lenders and investors nearly $60,000 on average in lost interest, property management fees, legal bills and resale commissions. Foreclosure not only is a financial sinkhole for homeowners, but for their lenders as well.

What's the significance here for you in the event of an unexpected financial emergency? Thanks to the spread of win-win home rescue plans, you are far more likely than ever to be offered a plan to help you get past your problem and keep your home. And since 80 percent of homeowners who enter a repayment plan manage to avoid foreclosure, you'd be smart to accept your lender's offer.