Do you owe a secured debt on your house or car?
When you buy a car or a house you sign a loan (or a mortgage) that is "secured" by the car or the house. (Sometimes other assets (like appliances) are secured when you borrow to buy them, but not usually.) When a debt is "secured" by an "asset" (like a house or car) you get a lower interest rate because there is less risk for the lender. The down side is that if you default on the debt, by not making payments or consistently being late in your payments, the creditor can "repossess" your car or "foreclose" on your house. In either case, you lose. And you can lose in two ways.
- You lose the car or house or other asset.
- You may still owe money. After they repossess your car or foreclose on your house, the creditor will sell the car or the house. And if they sell it for less than you owe (which is very likely), you still owe them the balance of the loan.
Make no mistake about this: If you fall behind in your payments, you should do whatever you can to make good, unless this will ruin your other finances.
There are several things you can do to make this situation better than a foreclosure or repossession, and they all involved debt negotiation with the lender.
First, you can try to adjust the terms of your loan. Do not try to do this with the people who call to threaten you if you do not catch up on your payments. Ask for the group in charge of "workouts" and try to make a deal. If you can convince them that you could pay off the loan if they adjusted the interest rate or length of time to pay, or both, then you have a chance to make a deal. On average, it costs the bank $50,000 to foreclose on a house, I have read. And if you offer them a deal that reduces their interest by less than that, they are going to be tempted.
If you cannot make a deal (or if you do not want to) and you think that the car or the house can be sold for more than the loan balance, the best choice is to sell the asset yourself, pay off the loan or mortgage and keep the balance. You can usually negotiate with the lender to stop making payments while you are in the process of selling.
If your mortgage is less than five years old (did you refinance recently?) be sure to check it carefully for "prepayment penalties" before putting it on the market. Even if state law forbids it, if you worked with a so-called national bank, your mortgage may have some stiff penalties for paying off the mortgage in less than five years (sometimes even longer). This is one more thing to be negotiated with the lender up front, BEFORE you sell.
Car loans do not usually have prepayment penalties, but you should check. If you think that the loan is for more than the asset can be sold, the best thing you can do is to try to negotiate a so-called "short sale". With a "short sale" you cooperate with the bank in getting the best possible price for your house without foreclosure proceedings, saving time and money for the lender, and they agree not to go after you for the balance owed above the sales price. Often they will just let you turn over the house to them and walk.
An Alternative to Debt Negotiation.
If you think you could keep up the payments on your car and house but you cannot handle the overdue amounts, then you should consider bankruptcy first. This might happen, for example, if you had a medical problem and could not make payments for a while, but you are now healed and back to work and could pick up the payments again, but you have this backlog handing over your head! you should consider bankruptcy.
Federal law offers two ways for people to manage their debt when it gets out of hand. Chapter 13 bankruptcy stops foreclosure, packages up your old mortgage debt into something you can deal with over time, and allows you to pay off unsecured debt (like credit card debt) at a fraction of the amount owed.
Chapter seven bankruptcy allows you to eliminate all or most of your unsecured debt (some categories, like unpaid taxes are excluded). Usually you get to keep your house and car, if you can continue to make those payments. It is not available to people who earn more than a certain amount, which differs from area to area. To do this effectively you really need a lawyer who specializes in this area. Read more about bankruptcy.
If you have lost your house or car and still owe money, then you should treat that debt as an unsecured debt. Check these sections: