Getting Legal and Tax Advice Before Foreclosure

If you are considering a short sale or foreclosure, getting advice from your accountant and a real estate lawyer should be one of the first items on your to-do list. You can do only so much research on the internet, but with laws changing and the laws in one state so different from the rest, it is worth the money to make sure you know your options. Also, sometimes general advice may not fit your specific situation.

Your Meeting with a Real Estate Lawyer

Your real estate attorney should ask you questions about your mortgage loans – what kind, when you received them and if the funds were used to purchase the home (vs. withdrawn in a re-finance or a home equity loan). Be prepared with your latest statements, the balances, and the paperwork you signed when you closed on your home or refinanced.

Here are some questions you should ask your attorney when you meet for a consultation.

What is the process of a foreclosure once I stop paying?

Foreclosure procedures are different in every state. Some states use instruments called Deeds of Trust for most mortgages, which allows the lender to skip judicial foreclosures and perform a quicker and easier Trustee Sale. Nevertheless, both types require that the lender give ample notice to the defaulting homeowner – usually at least 90 days. Your lender will be notifying you by mail of the Trustee Sale date.

Will I be liable for the deficiency after a foreclosure?

There are about 11 states that have what is called an anti-deficiency statute. This legislation protects individuals after foreclosure from being pursued by lenders or collection companies for the difference between what the home is worth and what is owed on the home. For example, if you have a home loan for $200,000 and the bank sells the home at $100,000 at a foreclosure sale (sometimes called a trustee sale), then your deficiency is $100,000. If you live in an anti-deficiency state (like Arizona or California), in most cases you won’t be liable for the $100,000. If you live in any of the other states without an anti-deficiency statute (like Florida), banks or collection agencies may be able to sue for the deficiency after a foreclosure.

Whether you are liable for the deficiency may be the key deciding factor in whether you should pursue a foreclosure, short sale or suck it up and keep paying on your mortgage.

If I am liable for the deficiency, what are my options?

If you are liable for part or all of your deficiency, your lawyer can advise you on your options. Some of those options include:

  • Short sale with negotiation with lender to forgive all or part of the debt. One of the happier outcomes of short sales is that you have an opportunity to negotiate with the lender to reduce the amount of the deficiency you may owe in the future. Though you may have to sign a promissory note, it is rarely for the full amount of the deficiency and often at 10-20 cents on the dollar.
  • Re-finance or re-negotiate the loan. If you want to stay in your home, but your payment is unaffordable, you should talk to your lender about some kind of loan modification. Though there are many cases where lenders are not being helpful, some homeowners are receiving some loan modification. Principle reductions are harder to come by – banks are being careful not to encourage owners paying their mortgage to ask for a principle reduction by handing their neighbors a principle reduction.


Your Meeting with an Accountant

Next, head over to your accountant to find out if the deficiency will be taxable. The Mortgage Forgiveness Debt Relief Act removes the tax liability for the forgiven debt on a primary residence foreclosure through 2012.

However, even for a second residence or an investment home, you may not be liable for taxes on the deficiency if you are insolvent at the time of the foreclosure, or if the loan is non-recourse, which means that the lender’s only remedy to default is to re-possess the home.

Make sure your accountant is familiar with the debt forgiveness rules stated by the IRS in publication 4681.