The Impact of an Upside-Down Mortgage
If you find yourself upside down on your mortgage, you likely won't be able to pay off the outstanding balance of the loan debt should you decide to sell your home. That's because you'll owe more on the property than it's currently worth. But even if your lender agrees to a short sale so that you can avoid foreclosure, there are a number of factors to consider.
Deficiency Debt
Since the lender will receive only part of the unpaid debt you owe on the mortgage, you may be responsible for paying the remaining amount. Following a short sale, the laws in your state may allow your mortgage lender to sue you for the deficiency. If the court places a deficiency judgment against you, the lender can collect on the judgment by garnishing a portion of your net wages or placing a lien on personal property or other real estate you own.
To avoid a deficiency judgment, you can try negotiating to get the lender to agree to accept a lump sum payment for an amount less than the balance you owe on the loan. That way the lender will get at least some of the money you still owe.
The lender may also allow you to make installment payments over a period of time to pay off the balance of the debt. Depending on your circumstances, the lender may even cancel the remaining debt rather than go to the expense of trying to collect the deficiency.
Higher Taxes
There are tax implications when you sell your home for less than its cost or adjusted basis—the amount you paid for the property increased or decreased by certain adjustments. Even if you sell the home at a loss, if it was your main home, you may not deduct the loss from your income on your federal tax return.
On the other hand, if the mortgage lender forgives any part of the debt remaining after you sell the property, you must report that amount as income when you file your tax return. While debt forgiveness may seem like a good resolution at first, you may have to pay more in taxes.
A federal exemption to not count as income forgiven mortgage debt due foreclosure is scheduled to expire in 2017. Also, in some states, you must report the cancellation of debt as income on your state income tax.
Lower Credit Score
A short sale may save your home from foreclosure, but it can negatively impact your credit score. Normally, short sales appear on credit reports as "settled." If that's the case, creditors who pull your report in the future will know that the mortgage lender took a loss by agreeing to accept less than the amount you owed. However, if your financial woes were unavoidable, you can protect your credit by asking the lender to report the debt to the credit bureaus as paid in full.
Not all lenders agree to do that though. Some lenders sell the remaining debt to collection agencies. In that case, having the account in collection can lower your credit score. How much your score drops depends on your previous credit score and the amount of unpaid debt.
To learn more about this process, contact real estate services that help people with homes for sale.
