Foreclosures continue to be in the headlines, while home values continue to decline as a reaction to the instability of the real estate market. This has left many homeowners feeling “trapped” in their homes because:
• They cannot sell the home for what it is worth
• They likely cannot re-finance due to valuation issues.
While homeowners may feel helpless when it comes to their situation, there are opportunities they can pursue to help get out from an upside down mortgage, including:
• Negotiate a loan modification. This may be an option, but banks typically have not been offering principal reductions.
• Work out a short sale with the bank. This is when a third party offers to purchase a property for less than the existing mortgage and the bank agrees to sell it for the reduced amount. This can still produce a debt obligation and/or taxable event for the homeowner.
• Execute a Deed in Lieu of Foreclosure with the bank. This is when the bank agrees to take the property back without going through foreclosure proceedings. This usually shortens the time period when the bank will take the property back, but a Deed in Lieu will still create a liability for the homeowner.
• Remove a second mortgage or home equity loan. This can be accomplished by filing a Chapter 13 reorganization to rebalance the home’s value.
• Let the house go into foreclosure. Homeowners can allow the bank to foreclose on the house and sell it at auction. However, this will most likely create a loan deficiency that will need to be dealt with by:
-Negotiating a settlement with the bank. Just be sure that the bank provides documentation that the full debt has been satisfied to avoid further collections down the road. This settlement may create a tax liability.
-Paying the loan deficiency off in full.
-Filing a Chapter 7 bankruptcy to eliminate the debt or a Chapter 13 to reorganize the debt to consolidate it at 0% interest. Most Chapter 13 plans will likely eliminate a portion of the loan deficiency debt as well as other unsecured debts.
What liabilities can occur by returning the property back to the bank?
1. If the bank agrees to waive the loan deficiency, they will likely send you a 1099 at the end of the year for the amount that they “forgave.” The amount forgiven is considered as “revenue” and you must pay taxes on it.
2. When the bank eventually sells the property, the homeowner will be responsible for the difference between the sales price and the balance of the mortgage note(s) plus other interest and fees.
It is possible for the bank to waive both of these potential liabilities, but it is not typical.
Our advice to our clients: get resolution. Unfortunately, many people are lured into a false sense of security, as they may not receive collection efforts on a loan deficiency immediately. If you know there is a deficiency, create a plan to deal with it.
Three options include:
• Seek debt resolution help with a reputable organization like GreenPath Debt Solutions. This is an opportunity to also deal with other debts that need resolution (i.e. credit cards, medical bills, etc).
• Proactively pay off the deficiency debt to avoid future interest charges and fees. If you have the available funds, great. If doing so will compromise your future (i.e. draining a retirement account), then we typically suggest finding other means to resolve the debt.
• File a personal bankruptcy to either totally eliminate the debt (Chapter 7) or set up court-authorized repayment terms at 0% interest (Chapter 13). Both of these solutions also provide other debt relief and protection from creditors and creditor actions.
Failing to act proactively can prolong the negative impact to your credit and interfere with future desires to purchase another home or obtain other sources of new credit. Allowing bad debts to linger will slow your credit improvement because new lenders will have continued concerns that the loan deficiency debt may be actively pursued (i.e. judgment and garnishment, sold to an aggressive debt collector, etc.) in the future and derail your budget and ability to pay them.
Finding lasting debt resolution will help you to regain financial control and move forward with your life and credit.
(Editor’s note: To learn more about guest blogger Bill Johnson’s practice, please visit his website at www.acclaimlegalservices.com.)