Deficiency Judgment After Foreclosure

Facing foreclosure is bad enough, but make sure you don’t make a bad situation even worse by owing money even after losing your home. Sadly, millions of Americans currently facing foreclosure don’t realize that there are several ways in which they could end up still owing money on their home, even after losing it to the bank. It’s important to consider deficiency judgments and possible tax implications before deciding whether to file bankruptcy, accept the terms of a foreclosure, consider a short sale, or keep the home.

Deficiency Judgment. When a lender or mortgage holder loses money on a home or other asset because you defaulted on a loan, they can come back to secure the remainder of the funds from you. This is called a deficiency judgment and requires the approval of a judge in order to place a lien against your assets or other income. For example, let’s assume you took out a mortgage of $250,000 for a home that was foreclosed upon and then resold for only $150,000. Depending on your state, the loss of $100,000 experienced by the bank is something for which you may be held responsible unless the bank agrees otherwise.

Find out if you have a “recourse” or “non-recourse” loan. If you have a non-recourse loan, it typically means that the lender will not recover a deficiency without filing a lawsuit. If you have a recourse loan, especially on a property that is not your primary residence, or if you reside in a non-judicial state, then the lender can seek a deficiency judgment. Bankruptcy is one method that many homeowners consider in order to eliminate the resulting debt and mortgage obligation.

Income Taxes. It might seem strange to discuss income taxes for someone facing foreclosure, but if a deficiency judgment is granted and then forgiven by the bank or lender, the amount is treated as income and is subject to taxation. Not only can this take many by surprise, but it often results in a higher tax bracket for the entire household– a consideration that could lead to potential federal tax liens or other serious debt obligations that cannot be easily eliminated, even when filing for bankruptcy protection.

Capital Gains Taxes. Another common scenario that takes many by surprise is the issue of capital gains taxes when facing foreclosure. For example, let’s assume you purchased a home with a mortgage in the amount of $200,000. Due to job loss and other financial situations, you fell behind and were unable to afford the minimum mortgage, eventually resulting in a foreclosure. The home sold for $225,000, so you may now be responsible for capital gains taxes on the $25,000.

Before making a final decision on the best course of action for your situation, speak to a financial counselor or other professional to determine if any of the above situations would affect you personally.

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