For many homeowners, a monthly mortgage payment is a constant source of stress. When the economy slows or you lose your job, you can fall behind on those payments. If this is the case, you may risk losing your home to foreclosure. Whether you're trying to catch up, or already facing foreclosure, it's important for any borrower to understand foreclosure consequences.
What is foreclosure?
To buy real estate, you probably had to take out a loan called a mortgage. Until you pay off your mortgage loan, your lender has certain interests in the property. If you fall behind on your mortgage payments (default), the bank or other mortgage holder can take back the property after a specified number of missed payments. The lender will sell the property to pay off your remaining mortgage debt. This is the foreclosure process. However, there is a lengthy pre-foreclosure process before the actual foreclosure auction is conducted.
It is important to note that a property owner can avoid the foreclosure process by offering a deed in lieu of foreclosure. This is when the borrower hands over the deed to the property to the lender to satisfy the debt.
A property owner also has the option to conduct a short sale, another foreclosure alternative. A short sale is when a homeowner sells their property for less than the amount they owe on their mortgage, provided the lender is willing to accept the short amount.
Some foreclosure proceedings are conducted through a judicial sale where the court supervises the process. Many states also allow for foreclosure by power of sale, otherwise known as nonjudicial foreclosure. This is when the mortgage lender sells the home without court supervision. In either case, the proceeds of the sale are used first to pay off the mortgage, and then any other lien holders. Any leftover proceeds will be paid to you, the property owner. If you owe more on your mortgage than the actual value of the property, your lender might pursue a deficiency judgment against you to recover the additional amount. In that case, you'll have lost your home and still owe more money.
Will foreclosure affect my credit score?
One of the most significant foreclosure consequences is the hit your credit score takes after the process is over. When financial institutions are deciding if they should lend you money, they evaluate whether or not you'll be able to meet the repayment obligation. Having a foreclosed property in your past raises a red flag that, because you couldn't pay your bills in the past, might indicate you'd have difficulty doing so in the future.
As a result, a foreclosure in your past lowers your credit score and can make it difficult to get new loans at good interest rates. It can even make it more difficult to find a job or a rental property, as many employers and landlords use credit reports as one way to assess your reliability. On the upside, your foreclosure will disappear from your report after seven years, and you can rebuild your credit by working on your debt and paying your bills on time.
Does foreclosure result in tax consequences?
Foreclosure tax consequences depend on if the debt is recourse or nonrecourse. Many people are unaware that with the cancellation of debt, the IRS considers it capital gains for income tax purposes. So, if you owe $300,000 on your house, it sells for $200,000 in foreclosure, and the bank discharges the remaining $100,000 debt, you must report that $100,000 as income on your taxes.
However, you may be able to exclude this income if you're insolvent, have filed for bankruptcy, or qualify for the Mortgage Forgiveness Debt Relief Act. During the Covid-19 pandemic, the government established a mortgage forbearance program for financial hardship related to the coronavirus, which has since expired.
Can I get my house back after foreclosure?
State laws vary on how foreclosure works. If you have the money, some states will allow you to regain ownership of your foreclosed home in a process known as “statutory redemption." Under this rule, you can reclaim your home if you can pay what the house sold for in the foreclosure sale.
You may also have to cover interest on the sale price, payable to the person who bought the house when it was foreclosed. Depending on your state, you have anywhere from 30 days to two years to attempt to reclaim your property under statutory redemption.
Having trouble understanding foreclosure consequences?
When you're struggling financially and having trouble making your mortgage payments, foreclosure is neither a quick fix nor a fresh start. Not only will you lose your home, but it will hurt your credit score, make it tougher to find work or new housing, and can even result in a hefty tax bill. You shouldn't make that critical a decision without understanding all of the major foreclosure consequences coming your way. Contact a foreclosure attorney to learn how a foreclosure might affect you.
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