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Deficiency Judgment After Foreclosure

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A deficiency judgment is an additional legal proceeding following foreclosure. Facing foreclosure is bad enough, but this bad situation can become even worse if you end up 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 the bank, even after losing their home. If you are facing foreclosure, it is important to understand deficiency judgments and any possible tax implications before deciding whether to file bankruptcy, accept the terms of a foreclosure, consider a short sale, or keep the home.

What is a Deficiency Judgment?

When a lender or mortgage holder loses money on a home or other asset because you defaulted on a loan, they can legally attempt to secure the remainder of the funds from you. This is called a deficiency judgment and requires the approval of a judge, who can then place a lien against your assets or other income.

For example, 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, you may be held legally liable for the $100,000 loss experienced by the bank unless the bank agrees otherwise.

Are You at Risk?

To determine whether you are at risk of a deficiency judgment, you should first find out if you have a “recourse” or “non-recourse” loan. If you have a non-recourse loan, it typically means that the lender cannot recover a deficiency without filing a lawsuit. This means you are more protected against a deficiency judgment, although the lender still can institute legal proceedings.

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. If the lender does in fact seek this judgment, many homeowners consider bankruptcy in order to avoid having to pay the deficiency judgment

Tax Implications

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.

The issue of capital gains taxes also takes many homeowners by surprise when facing foreclosure. For example, 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. This, too can have serious tax implications.

Steps to Take

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 you are likely to experience a deficiency judgment or tax liabilities as a result of you foreclosure.

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