Do You Lose Your Retirement in a Foreclosure Proceeding?

In the 2007-2008 financial meltdown the U.S. residential housing market collapsed, a recession followed and unemployment soared to nearly 10 percent. As of September 2010, jobs and housing remain distressed. Many owners find themselves "upside down," with mortgages greater than the current value of their homes. Other unemployed or underemployed homeowners cannot pay their mortgages. Foreclosures have climbed to a record high, up 25 percent from 2009. Homeowners faced with foreclosure worry that the process will strip away everything they own, even their retirement savings.

Non-Recourse and One-Action Rule States

In many cases, a foreclosure will have no effect on retirement savings or any other assets. Some states, "non-recourse states," do not allow any proceedings against the borrower other than the foreclosure itself. Other states have a different rule, the one-action rule, which says that lenders may institute only a single suit to collect a mortgage debt. This has the same effect as the non-recourse rule, because the foreclosure itself constitutes that single suit. See a list of non-recourse and one-action rule states in the Resources.

Foreclosures in Other States

In other states the lender can file a lien against other assets following a short sale (a sale for less than the amount you owe the lender). In practice, this happens only when the borrower has substantial assets. In this circumstance, the lender may exercise a right to lien non-ERISA assets intended for retirement purposes, such as a rental property. The lender has no right to ERISA-qualified retirement funds, such as a 401(k), 403(b), all IRAS, Keogh, profit-sharing plan and certain defined-benefit plans.

Foreclosure and Retirement Assets under Chapter 7

Some homeowners facing foreclosure will file bankruptcy, usually under either Chapter 7, liquidation, or Chapter 13, reorganization. According to the American Bar Association, under the Chapter 7 statute a married couple may exempt a total of $32,300 from bankruptcy proceedings. State laws regarding exemptions vary. You can include assets informally committed to retirement funding, such as a rental property, within that exemption up to the limit of the allowed amount in your state.

Exempt Assets in Chapters 7 and 13

Under both Chapter 7 and Chapter 13, designated ERISA-qualified retirement funds have exempt status. The bank has no right to them, even if after the foreclosure sale you still owe the bank money on the mortgage.

Wage Withholding vs. Voluntary Payments

If you have borrowed from your retirement plan and have amounts automatically taken from your paycheck to repay the plan, a bankruptcy petition protects these repayments, even if you owe your creditor money after a foreclosure and short sale. If, on the other hand, you made voluntary payments into your retirement plan prior to bankruptcy, the court will generally require you to discontinue these payments in a Chapter 13 bankruptcy if after a foreclosure and short sale you still owe your lender money -- unless you live in a non-recourse state.

References

• "Lessons from the Financial Crisis: Causes, Consequences and Our Economic Future"; Robert Kolb; 2010
• Realty Trac: Job Losses Foreshadow More Foreclosures Deals, Risk
• Bloomberg: U.S. Home Seizures Reach Record for Third Time in Five Months
• Nolo: What Happens to Your Retirement Plan in Bankruptcy?
• American Bar Association: "Straight" Bankruptcy: Chapter 7

Resources

• HELOC Basics: List of Non-Recourse Mortgage States and Anti-Deficiency States