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A bank’s usual remedy for a borrower’s default on a mortgage is sale of the property by trustee sale or foreclosure. In a foreclosure there is an auction of the property by the bank. Today there is a rising trend among homeowners to take action before they are foreclosed upon.
Borrowers unable to make their mortgage payments are resorting to short sales. In a short sale, the lender allows the home to be sold for less than the balance owed on the loan and discharges the difference – in theory. Borrowers may qualify for short sales when the value of their home is less than their debt owed.
Many borrowers see a short sale as a more appealing alternative to foreclosure because it is not public record, may have a less significant effect on future employment, and may be less restrictive on your ability to get loans in the future.
When the housing market crashed, home values plummeted. Throughout the country, homeowners found themselves owing more on their mortgages than the value of their home. Many Americans went into foreclosure or held short sales, both of which yielded prices substantially lower than the mortgage. Many lenders forgave this difference on the loan balance, however because it was discharged it was considered income and the borrowers were taxed on it.
The government responded by passing the Mortgage Forgiveness Debt Relief Act of 2007, which provides a tax exemption for the loan debt that was forgiven. 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. 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.
A current concern of many homeowners in risk of short sale or foreclosure is that this act is set to expire at the end of 2012. This would mean that on top of losing their home at a reduced price, the homeowners would be responsible for taxes on the forgiven amount. Fortunately, members of Congress are lobbying to have the Act extended for another one to three years, although the fate of this effort remains uncertain.
While the housing market was on the rise many homeowners took out second mortgages and home equity lines of credit (HELOC) to finance expenditures unrelated to the home itself, like education or medical bills. This seemed like a good idea in the peak of the market 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 satisfy their primary mortgage, but often their debts were not eliminated completely. The bank holding the primary mortgage may have agreed to a short sale without the secondary lender’s consent.
If you took out a second mortgage on your home for reasons unrelated to the home, these secondary lenders may come after you for the debt that remains. This is because secondary lenders get the residual equity from a sale after the primary lender has received their full payment. If there was not enough to pay the primary lender, there is no residual to go to the secondary lender. Accordingly, in order for the short sale to get approved by the second mortgage, the second position lender would sometimes reserve the right to sue the borrower even AFTER the short sale. Unfortunately, many borrowers eager to see the short sale go through, many not have realized the implication of this “reservation of rights.” Practically speaking, it means there are cases where a short sale has already occurred and now the (former) homeowner is being sued by the second mortgage or HELOC lender for that loan amount.
Once your house is out of the picture, these debts essentially become unsecured but your lender retains the right to pursue them against you. An attorney experienced in 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. At McCarthy Law, our attorneys have the experience to explain the facts and help you to get on the right path to debt resolution. If you still have mortgage debt after a short sale or foreclosure, please contact us for a free consultation with an attorney.