Many borrowers are concerned about personal liability from mortgage foreclosure deficiency judgments. If someone has lost equity in a house that is foreclosed upon, there is a chance of a deficiency judgment. A deficiency judgment refers to a mortgage lender’s judgment against the borrower for the difference between the balance of the mortgage note, plus costs and attorneys fees, and the value of the property foreclosed. The property value is determined on the date of the foreclosure sale. Personal liability from mortgage debt is a major reason for asset protection.
Many borrowers are under the false impression that a foreclosure will automatically result in a judgment against them personally. This is not the case. In order to obtain a deficiency judgment against the borrower the Bank is required to file a motion for a deficiency after the foreclosure sale, and the court is required to conduct an evidentiary hearing to determine the deficiency amount (if any). At the evidentiary hearing the mortgage lender has to prove that the property’s value on the sale date was less than the amount the borrower owed on the note. However, the borrower is allowed to refute the evidence of the Bank, get his own appraisal or can even use the government’s tax assessed value as evidence of value (which is usually higher than the Bank’s appraised value).
Deficiency liability is a major problem in Florida’s declining market. Banks can go after the deficiency judgments themselves or sell the rights to pursue mortgage deficiencies to third parties. It is important that borrowers protect their assets ahead of time to prepare for a possible deficiency hearing or judgment against them. Florida law gives mortgage lenders five years to pursue a mortgage deficiency claim. If a deficiency judgment is granted it lasts for up to twenty years in the State of Florida.
Second mortgage lenders and private lenders also have the right to pursue borrowers for a deficiency judgments, and in many cases are more likely to do so. There has been a significant increase in second mortgage lawsuits since the beginning of 2009. Banks that made commercial loans almost always file a lawsuit against the individual borrower to enforce and collect upon the promissory note or personal guarantee of a business loan.
If a mortgage lender pursues a deficiency judgment, it is in your best interests to hire an attorney to defend the deficiency. In some cases, an attorney can use procedural and substantive defenses to mitigate a deficiency claim. Also, an attorney may be able to negotiate a more acceptable settlement for much less than the total deficiency liability.
Chapter 13 Bankruptcies offer one way to avoid deficiency judgments. Also, a borrower has the same rights to modify his mortgage in Bankruptcy as borrowers that are not in Bankruptcy. The HAMP mortgage program was modified this year to eliminate bankruptcy as an obstacle to mortgage relief.
Another problem with mortgage foreclosure is possible income tax consequences. Generally, when a Bank forgives or cancels a debt, the borrower incurs income tax liability on the amount that was “forgiven” by the Bank. Usually you will receive a tax form 1099 telling the IRS that you have imputed income for the amount of debt reduction. You will also incur income tax liability for a deed in lieu of foreclosure. The taxable income will be the difference between the property value and the balance of the mortgage loan on the date you surrender the property to the bank.
A foreclosure may result in cancellation of debt income depending on whether the bank pursues a deficiency judgment. If the mortgage lender gets a deficiency judgment for the difference between the property value on foreclosure sale date and the mortgage balance the lender is not forgiving any part of the loan. Therefore, in some cases having a deficiency judgment against you may be better than having an income tax liability. This can be the case, if the Bank is unable to collect on its deficiency judgment based on the borrowers estate planning and asset protection devices that have been set up.
In late 2007, Congress passed the Mortgage Forgiveness Debt Relief Act which protected many debtors from income tax liability associated with foreclosure avoidance. This Act states that homeowners will not be subject to income tax from release from mortgage liability if and to the extent the mortgage proceeds were used to buy or improve their primary residence. Unfortunately, there is no protection from income tax liability for vacation homes or businesses. However, borrowers in these situations can still have their tax liability relieved through Chapter 7 or Chapter 13 bankruptcies.