Short Sale Debt
Short Sale vs Foreclosure Debt
When you default on your mortgage, your bank’s usual remedy is the sale of the property by trustee sale or a foreclosure. In the case of a foreclosure, there is an auction of the property by the lender however, there is a rising trend among homeowners to take additional action before they are foreclosed upon. In many cases when borrowers are unable to make their mortgage payments, they are resorting to a short sale. A short sale is when the lender allows the home to be sold for less than the balance owed on the loan and discharges the difference, and qualified when the value of their home is less than their debt owed. This has been a more appealing alternative to foreclosure because it is not public record, may have a less significant effect on your credit and future employment.
Tax and the Mortgage Forgiveness Debt Relief Act
When the housing market crashed, home values plummeted and homeowners found themselves owing more on their mortgages than the value of their home. This still has yet to recover in many markets in California. Many Americans went into foreclosure or held short sales, both of which yielded prices substantially lower than the intial mortgage balance. Knowing this, lenders forgave this difference on the loan balance but the IRS did not. Because it was discharged it was considered income and the borrowers were taxed on it.
Our government responded by passing the Mortgage Forgiveness Debt Relief Act of 2007, which provides a tax exemption for the loan debt that was forgiven. However, the Act came with several restrictions, including that the loan secured had to be for the primary residence or used to improve that house. For example, a homeowner owing $100,000 on their mortgage may negotiate with their lender to have the house sold for $75,000. The lender would essentially forgive the remaining $25,000. and the government would consider this $25,000 as income because it was money that would otherwise be paid on the loan. Before the Mortgage Forgiveness Debt Relief Act, it would be subject to federal income taxes.
Short Sale Debt FAQ
When the housing market was on the rise, many homeowners took out second mortgages and home equity lines of credit (also known as a HELOC) to finance expenditures unrelated to the home itself, like education, a new car or medical bills. All of this seemed like a good idea at the time but when housing prices dropped, the value of the home could no longer cover these debts. In the midst of the recession homeowners resorted to short sales to try to satisfy their primary mortgage loan, but often their debts were not completely eliminated. The bank holding the primary mortgage may have agreed to a short sale without the secondary lender’s approval.
If you took out a secondary mortgage on your home, and did so for reasons unrelated to the improvement of the home, these secondary lenders may come after you for the debt that remained. Secondary lenders get the remaining equity from a sale after the primary lender has received their full payment but if there was not enough to pay the primary lender, there is no residual to go to the secondary lender. In order for the short sale to get approved by the second mortgage lender, they would sometimes reserve the right to sue the borrower even after the short sale. With many borrowers eager to see the short sale go through, they many not have realized the implication of their short sale already occurring.
Once your house is transferred and out of the picture, these debts essentially become unsecured but your lender still retains the right to pursue them against you. An attorney experienced in mortgage debt settlement can negotiate with your lenders to reduce this leftover short sale debt down to manageable settlement in full. This has been only a general overview and as with any tax or legal question it is important to speak to a professional with knowledge in the field. If you still have mortgage debt after a short sale or foreclosure, please contact us for a free consultation with an attorney.