Can You Have a Foreclosure Deficit Forgiven?
When a homeowner loses his home to foreclosure for not making his monthly mortgage payments, the bank will sell his home at auction. The lender can collect the difference, known as a foreclosure deficit or deficiency, between the auction price of the home and the remaining mortgage principal. The lender can either forgive the debt or obtain a deficiency judgment against the borrower to try to collect owed monies if state law permits the lender to do so.
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Cost
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If a homeowner has a small foreclosure deficit, the lender may decide to forgive the foreclosure deficit because of the expense to hire an attorney, pay for court costs and comply with state and federal collections laws. Because certain foreclosed-upon homeowners will have few assets with which to pay the deficiency balance and may not have a job, the lender has to balance her successful collections rate and the amount of time she has before the statute of limitations expires on the deficiency with that of her estimated expenses to collect the debt.
Geography
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Not all states allow a lender to collect a foreclosure deficiency on a first mortgage. In non-recourse states, including Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah and Washington State, a lender must choose between foreclosing upon a property and pursuing the balance of the loan as of 2011, according to Foreclosed Dreams. A lender almost always will choose to foreclose on a property because the homeowner can keep the house if the lender chooses to sue the homeowner .
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Deductions
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In states that do allow lenders to collect foreclosure deficits, lenders predominately forgive debt in order to write it off as a loss, taking a tax deduction worth up to 35 percent on their tax return, according to Gimme Law. This return usually exceeds their collection rates from foreclosed-upon debtors. They can add to their losses any fees and expenses agreed upon in the contract, potentially allowing them a much higher tax deduction than their actual losses from foreclosure.
Warning
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If a taxpayer does have a foreclosure forgiven, he may have a tax liability at the federal and state level because the U.S. government considers cancelled mortgage debt as income. As of 2011, the Mortgage Forgiveness Debt Relief Act allows a homeowner a tax exclusion on up to $2 million in cancelled debt on a primary residence, according to the IRS. Forgiven debt on a second mortgage does not qualify for an exclusion unless the homeowner used the second mortgage to make improvements to the property.
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