A Consumer’s Post-Foreclosure Liabilities

There are various reasons that may cause a homeowner to default on their home loan.  Divorce, separation or unemployment may deprive a consumer of the income necessary to service the home loan, which will eventually lead to the foreclosure of the residence.   In some cases the homeowner may try unsuccessfully to save the house through a loan modification.  In other instances, the homeowner may try to generate as much money as possible through a short sale, with all of the proceeds going to the lender.  Finally, some homeowners may abandon the property because they are unable or unwilling to make the payments – what is referred to as a “strategic default”.  A homeowner may choose a strategic default because the house is worth considerably less than the mortgage balance, or because the house no longer is adequate to serve their needs.  In any of the situations, the mortgage company will eventually foreclose on the property.  In many situations, this may be the end of the homeowner’s liability, and they can take steps to rebuild their credit.  However, there is always the possibility that the lender may still pursue the homeowner for the balance owing on the mortgage.

When a lender forecloses, it incurs additional charges and expenses that are added to the loan balance.  Any attorney fees and foreclosure costs will be assessed against the loan.  In addition, there will often be charges advanced by the lender for property taxes, maintenance costs and insurance that will further increase the loan balance.  The end result is that the amount of the mortgage debt will be higher than at the time of the original default.  This in turn means that the likelihood of the lender selling the property for enough money to pay off the loan will decrease significantly.  The inevitable result is that the homeowner will still owe the unpaid balance of the home loan to the lender.  This is referred to as a “deficiency”.

Fortunately, Georgia homeowners enjoy an additional layer of protection from a deficiency claim than do residents of most other states.  In order for a lender to pursue a deficiency claim in Georgia, they must the sale confirmed within thirty (30) days of the foreclosure.  Failure to do so will prevent the lender from suing the former homeowner, and attempting to collect the money through a wage garnishment.   While most lenders fail to take this additional step, there has been a subtle rise in the amount of lenders who are not content with recovery of their collateral, and attempt additional collection of the debt.  In addition, Georgia residents are only protected by the confirmation requirement if the property was located in Georgia.  Our firm has represented numerous clients who relocated to Georgia from other states after a foreclosure, and were actively pursued by a mortgage lender on a deficiency claim.  In addition, Georgia residents are only protected by the confirmation requirement if it is the original lender attempting to collect the debt.  For instance, if the loan was a VA loan or USDA loan – guaranteed by the federal government – then those agencies will attempt to collect the deficiency amount from the borrower.  This can be exceptionally problematic for anyone who is receiving certain federal benefits, as the money will be administratively garnished from those benefits.

Even if the lender chooses to forego collection of the deficiency claim, it does not mean that the consumer is out of the woods.  A more common scenario is that the lender will not try to collect the deficiency claim, and will instead choose to write the debt off.  A “write off” means that the lender will no longer attempt to collect the debt.  While this would seem to be the best possible outcome for a former homeowner, it creates a new peril.  When a lender writes off the debt, it may send a 1099-C to the IRS.  Depending upon the consumer’s circumstances at the time of the foreclosure, the amount of the deficiency claim that was written off by the lender will actually be treated as income.  This is more commonly known as “Cancellation of Debt” income.  In simple terms, the amount of the debt that the lender “wrote off” is treated the same way as if the consumer had “earned” that amount of money, which can generate a significant tax liability.[i]  Various lenders have become more willing to write off debts in recent years, especially if they were not guaranteed by a third party.  In other instances, lenders are actually rewarded by the federal government for writing off the debts.  Regardless, in the classic case of adding insult to injury, the foreclosed homeowner has not only lost their residence, but could potentially face a huge tax liability.

A bankruptcy can protect a homeowner from the collection of a deficiency claim.  In addition, if the mortgage deficiency has been discharged in a bankruptcy, then the lender will not be able to “write off” the debt and create tax consequences for the consumer.  If you have suffered a foreclosure, it is highly advisable that you meet with a bankruptcy attorney and determine what action, if any, will be necessary to protect you from post-foreclosure liability.

[i] See your tax professional regarding the treatment of a 1099-C.