Monday, February 16, 2009

Loan Modifications, Foreclosures Affecting Retirement Savings (IRAs and 401k)

house under waterWith foreclosure rates sky rocketing and no end in sight, banks are much more willing to negotiate with homeowners on the specifics of their mortgages. These days, “loan modification” have almost become an industry by itself as banks allocate more and more resources to work on this.

Sparked by all the news surround it, a reader had this question:

What happens to IRAs and other retirement accounts when someone approaches a bank asking for a loan modification? Can the bank take over those retirement savings to satisfy part of the debt (in the case of a short sale for example)?

Loan Modifications

A loan modification is basically a change to the terms of your loan. In theory, it could be lower interest rates, shorter loan terms or even completely writing off the whole mortgage.

From what I’ve read (and heard), lenders will not agree to any loan modification unless you start to show inability to repay the monthly mortgage payments. Once delayed (or missing) payments become frequent though, they might work with you on a loan modification.

The modification process is basically a negotiation where the lender will reduce your monthly payment if it believes it is better off with you paying a reduced mortgage payment. Therefore, the modification needs to be better than your house being in foreclosure (in the bank’s eyes).  In process, the retirement accounts are safe because they are still working with you to get you current with the mortgage payments.

What About Foreclosures

Think of foreclosure as a few months of non-payment.  If loan modifications weren’t enough to reduce your payment to an affordable level (or if there were no loan mods to begin with), a notice of default may be sent to your house after 90 days of missed mortgage payments.  At this point, the lender will seize your house and put it up on auction in an attempt to recoup the cost of lending you money.

If the proceeds doesn’t cover all the cost  such as mortgage, administration fees, lenders may initiate a deficiency judgment (basically, they are suing you to get their money back).  Most believe that lenders won’t even bother with this because this process is long, complicated and expensive.  The argument is that if a homeowner weren’t able to repay the mortgage in the first place, he/she probably don’t have enough funds for the legal actions to be worthwhile.

If however the lender do decide to sue and win in court, you are obligated to repay any debt that the judge grants to the lender.  At this point, it is like any other time you owe someone else money in which you try to repay it with all means possible (job, 401k withdraws etc).

If you don’t want to take money out your 401k and IRA, you can always file for bankruptcy where those types of accounts are safe from debtors.

The Shorter Answer to the Question

Basically, 401ks and IRAs are safe from all types of debtors even though other types of assets (savings, other investment properties and taxable investing accounts) could be in danger.  However, in the case of fraud (as determined by the court), nothing is safe.


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