Question: We made a big mistake three years ago, and are now in potential trouble. We obtained an interest only loan, and put down only five percent of the purchase price. I have just lost my job, and cannot afford to pay the high monthly mortgage payments. We have considerable equity in our house, but we have started to receive threatening letters from our mortgage lender. What should we do?

Answer: You may or may not have made a big mistake by obtaining an interest only mortgage loan. On the one hand, your principal balance remains the same; what you borrowed three years ago is what you owe today. On the other hand, would you have been able to purchase the house without that interest only loan?

Although you have lost your job and are in financial trouble, in some ways you have been fortunate. Over these past three years, home values have appreciated at an unbelievable pace. At least, if you are forced to sell, you will have some money in your pocket.

However, if and when home prices start to depreciate, an interest only loan can be a disaster to your health -- and to your pocketbook.

None of us can appreciate -- nor anticipate -- the future. Although we always believe it will never happen to us, once in a while, calamity strikes, and then we have to address these very hard and difficult questions.

I know it will not be a consolation to you, but you are not alone. Recently, a website devoted to foreclosures reported that some 28,190 new foreclosed residential properties were listed for sale in the United States during the month of March, 2005. According to the report, this was an increase of 50 percent over the previous month (www.foreclosure.com ). While I cannot vouch for these statistics, the fact remains that more and more lenders are starting to foreclose on the American homeowner.

There are a number of steps you should take when you start to get behind on your mortgage payments.

If you want the lender to cooperate with you, there has to be an equal level of cooperation on your side. Indeed, according to the FreddieMac guidelines on alternatives to foreclosure, the secondary mortgage market gives a mortgage lender broad discretion to extend relief:

"to a borrower who encounters hardship, is cooperative and has proper regard for fulfilling obligations..."

The first possible relief is referred to as "temporary indulgence." Here, the lender, on request, may grant the borrower a short period of time -- usually not more than three months -- in order to cure any delinquency. However, this is only temporary relief, and by the end of that short period of time, the borrower must be completely current. And it must be noted that the keyword is "cooperative;" borrowers must be willing to talk with their lenders immediately, once they start having financial problems.

Another approach is a repayment plan. Here, the borrower is given a fixed period of time -- usually not to exceed one year -- in which to bring the mortgage current, by immediately making and continuing to make payments in excess of the monthly mortgage payment. It is important to get this repayment plan reduced to a written document, signed by both the lender and the borrower.

Lenders also can enter into what is known as a special forbearance relief agreement, whereby the regular monthly mortgage payments are suspended or reduced for a period of up to eighteen months from the due date of the first unpaid monthly installment. At the conclusion of this relief period, the regular payments must be resumed; additionally, a comprehensive plan must be agreed upon for the repayment of the amount that has been suspended.

In this case, the lender will make a determination that the default is curable, and based on the current financial and appraisal data, the lender must be satisfied there is a likelihood that the borrower will be able to comply with the repayment plan. Clearly, the burden is on the borrower to document and justify the plan, so as to satisfy the lender's requirements. Again, your cooperation is mandatory.

If you are in the military, the Soldier's and Sailor's Relief Act provides various forms of relief, but you should check with your military or civilian lawyer to determine your eligibility under that Act.

Another avenue that may be available to you is known as a "short sale." This approach is generally used when the value of the house is less than the amount of the mortgage. Here, the lender will authorize you to sell the property for what it is really worth, and the lender will get all the proceeds. Let us look at this example. The house can probably be sold for $175,000, but the mortgage is $200,000. The lender may allow you to sell the property for $175,000, giving a real estate broker a three percent commission. The lender gets all the remaining sales proceeds; you get nothing from the sale. However, what is important is that you will be relieved of your mortgage obligations. In some cases -- depending on your financial situation -- the lender may want you to pay a portion of the mortgage shortfall; this depends on the lender and is clearly negotiable.

The deed, in lieu of foreclosure, is another remedy that may be available to you. Under this arrangement, you deed your property to the lender (or to whomever the lender designates) and this is in lieu of (instead of) foreclosure proceedings. This arrangement is an acceptable and customary procedure when, for example, the borrower is deceased and the estate is willing and able to transfer the property, or the borrower has filed for bankruptcy relief, and the trustee has abandoned interest in the property.

There are a number of requirements in order to accomplish a deed in lieu, and each lender will have their own set of guidelines. Generally speaking, however, the following requirements are usually imposed by a lender that is willing to accept the deed in lieu:

1. The borrower has a valid and documented reason for default, which is beyond the borrower's control;

2. The borrower has demonstrated that he or she has, and can make, prudent financial decisions since the default;

3. The borrower has been cooperative and has provided all necessary documentation to the lender. Additionally, the borrower must permit the lender to have reasonable access to inspect the inside of the property;

4. The borrower must be willing to make a financial contribution, if this is at all possible; and

5. If the lender has escrowed monies for the payment of future taxes and insurance, the borrower must be willing to forego reimbursement of these escrowed funds.

Additionally, the lender will not even consider taking the property as a deed in lieu unless the property has been listed for sale at market value, and all attempts to sell the property have failed. Finally, there can be no outstanding liens or other encumbrances on the property (such as real estate taxes), since the lender wants to be able to take the property free and clear of any other claims against it.

When a lender takes property as a deed in lieu, presumably the borrower's credit history has already been tarnished; after all, the borrower has probably not been making mortgage payments for several months. However, it is my understanding that a deed in lieu will not get reported as a foreclosure on your credit history, and thus if the lender is willing to accept the deed in lieu of foreclosure, at least you may be able to avoid even further negative credit history.

It is strongly suggested that you contact your lender immediately, and have a face to face discussion with them. If your lender is no longer in your home town, send them a letter and then pick up the telephone and make arrangements to talk to the most senior official at that mortgage lending company.

The final option, of course -- which should be used only as a last resort -- is for you to file bankruptcy. Congress is about to enact new bankruptcy legislation, which will change some of the basic rules for many American consumers. However, when someone files for bankruptcy, there are many protections that automatically apply from the day the bankruptcy petition is filed with the Bankruptcy Court. The most important protection under the bankruptcy law is known as "the automatic stay." If you are in bankruptcy, no legal action can be taken against your house unless the lender requests the Court for permission to "lift the stay." This means that the lender goes before the bankruptcy judge, in open court, and petitions the Court to permit the foreclosure to take place. This is called "lifting the stay." Depending on the circumstances, including the amount of equity you have in your house and the possibility of getting back on your feet financially, the Bankruptcy Court may or may not lift that stay.

In your case, it is strongly recommended that you immediately talk with your mortgage lender and try to work something out. Alternatively, since you do have a lot of equity, you should consider putting your house on the market for sale. Interest rates are still low -- and consumer demand for housing remains strong. There is no guarantee that this situation will continue. You might as well take advantage of the good real estate market conditions, while they last.

You cannot ignore the problem, hoping you will win the lottery or find some other immediate source of funds.