There’s little doubt that foreclosure, short sale and REO numbers are down. Fewer distressed properties bring greater stability to the marketplace and no doubt account for some of the price increases which have been seen in the past year — it’s not so much that prices have sharply risen instead it’s the statistical reality that we have fewer discounted properties being sold.
All of this sounds pretty good but for many American households a huge problem looms ahead: If your property was foreclosed or you gave up your home with a short sale it means the entire debt owed to the lender has not been repaid. In many jurisdictions you could be subject to a “deficiency judgment” that might total tens of thousands of dollars or maybe more.
The threat of a deficiency judgment is the last arrow lenders have in their quiver. It used to be that when a property was foreclosed or sold as a short sale that three hideous financial events took place:
First, the borrower’s credit was demolished.
Second, the lender’s loss on the property was considered “imputed” income for tax purposes. This meant that the Internal Revenue Service (IRS) could go after borrowers who had not fully repaid their mortgage, seeking to tax “income,” which did not exist in the form of cash or any kind of material asset. In other words, if you owed the lender $300,000 and paid back $225,000 then under the imputed income rule the IRS would seek taxes on the $75,000 that was unpaid.
Third, in many states, lenders could go after defaulted borrowers with a “deficiency judgment,” a court suit to collect losses not covered by mortgage insurance.
In practice mortgage borrowers today are in much better shape. Here’s why:
It can take as long as seven years to again qualifying for a new mortgage once a home has been lost the foreclosure. However, in some cases borrowers may once again qualify for mortgage in as little as two years.
Many homes that would’ve been foreclosed several years ago have been saved through the government's HARP and HAMP programs.
Under the Mortgage Forgiveness Debt Relief Act of 2007, the IRS is no longer allowed to regard most unpaid mortgage debt as taxable income. This legislation was supposed to end December 31, 2012, but was extended to January 1, 2014.
But what about deficiency judgments? Writing in The Washington Post, Kimbriell Kelly said deficiency judgments are allowed in 40 states and the District of Columbia. The catch?
“A recent government audit found the recovery rate at one-fifth of 1 percent,” wrote Kelly. “But for those hit with the judgments, it can seem like double-dipping on their pain.” (See: Lenders seek court actions against homeowners years after foreclosure, June 15, 2012.)
The report mentioned by Kelly shows that in 2011 Fannie Mae and Freddie Mac “pursued 35,231 deficiency accounts, with a combined value of about $2.1 billion. Of this amount, vendors recouped approximately $4.7 million — about 0.22 percent.”`
The real percentage is much lower, of course, because relatively-few foreclosures or short sales result in collection efforts.
Indeed, deficiency judgment collections seem so low that they hardly seem worth lender efforts or much borrower worry. However, that’s not quite the case.
Those who have been foreclosed rarely have the assets or income in the short run to pay off massive claims, but lenders can have a number of years to file a deficiency judgment. That means as savings increase and income grows a borrower could be hit with a claim once they're back on their feet. A judgment once obtained may be collectible for as long as 20 years according to the Wall Street Journal.
For many distressed borrowers the foreclosure crisis is not over, it's simply on hold.
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