Your financial problems related to mortgage may not end after closing out your loan through a short sale or foreclosure. Well, you may end with a severe financial liabilities or tax burden determined on the basis of the original terms of your loan as well as the state you‘re residing. You may need to pay your lender if the sale proceed is not enough to cover the balance you owed on the loans that is secured by the property.
What is a deficiency balance?
The difference between the amount you owed and what the home sold for is known as deficiency balance. However, some of the lenders may forgive a deficiency balance and other may not. In reality, the lenders may not sue you for a deficiency balance.
There are some of the states that protect their citizens with anti-deficiency laws. However, rules vary from state to state, so you need to check with your state laws to acquire more information.
Do you have a non-recourse or recourse loan?
You can be liable for a deficiency balance depending on the loan you incur like a non-recourse loan or a recourse loan.
What is a non recourse loan?
The lenders may not be able to retrieve the defaulted loan to the assets used as collateral against the loan, only if you owe a non recourse loan. In case of the mortgage loan, you may use your home as the only security. In case you have a non-recourse loan and the lender forecloses on your property, he may not be able to get a deficiency judgment. The lender can only foreclose on the property and keep the proceeds.
Most of the non recourse loans are used to buy primary residence. You may not be able to prevent the lender from getting a deficiency judgment if he foreclosed on your investment property or vacation home. But you’re also liable for the deficiency balance if you obtain a loan on a primary residence, which is no longer your primary home.
What is a recourse loan?
If you’ve a recourse loan, then the lender is legally liable to collect the deficiency balance. However, he can start the collection along with suing you in the court. If the lender wins the judgment, then the court can order to levy your account to satisfy the creditor.
In certain cases, the lender can sell the debt to a collection agency that can pursue you to collect the owed amount. It depends on the lender whether he wish to sell the debt to collection agency. Most of the lenders are smart enough to understand if he foreclosed on the property, you’re undergoing financial hardship, and it can make the collection difficult.
Are you aware of the tax implication?
There are some of the lenders who may write off the debt instead of trying to collect it from you. The remaining balance forgiven by your lender can be considered as taxable income by the IRS.
A 1099-C given by the lender to the IRS notifying the amount that is forgiven or canceled, if it exceeds $600. If the lender sends you a 1099-C form, then he has forgiven the debt. You need to report the amount shown on the 1099-C as income while filing your income tax return.
According to the Mortgage Forgiveness Debt Relief (MFDR) Act of 2007, it can help the taxpayers to exclude income from the discharge of debt on their principal residence. However, you can avail the benefit of this Act only on the mortgage debt that you incurred while purchasing your home. The MFDR Act may not cover you if you obtain loan against the equity in your home in a refinance.
Therefore, you need to consider the type of your home mortgage in order to understand the effect of deficiency balance on your financial situation.
This article has been contributed by Sam Stokdale, a financial writer specializing in mortgage. Immersing himself with the financial sector, he has covered topics including real estate investment, mortgage refinancing, lending and borrowing, managing finances and credit advice.
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