by Stuart Pack, Partner, Nagle Law Group
The typical prime concern of most homeowners considering whether to walk away from their mortgage or short sell their home is the potential financial liability they have to their mortgage lender after a foreclosure or short sale. Although Arizona’s anti-deficiency laws frequently protect the homeowner from a deficiency judgment, this article explores some of the secondary consequences resulting from strategically defaulting on a mortgage or short selling a home.
Credit Issues
- Credit Score – Most people are aware that walking away from a mortgage or short selling their home will hurt their credit score. It is impossible to predict the precise impact to one’s credit score, as this depends on the pre-foreclosure or pre-short sale credit score, past credit history and numerous other considerations. Whether a person chooses to short sale or walk away, recent studies have shown there is little, if any, difference to a person’s credit score. However, by no means will walking away or short selling “ruin” your credit score. No matter how low your score may drop, you certainly have the ability to help it recover.
- Credit Report – A foreclosure will remain on a person’s credit report for seven years.
- Credit Cards – In addition to the hit to a person’s credit score, it is not uncommon for credit card companies to cancel credit cards or lower a person’s credit limit as a result of missing mortgage payments. It is also common that it will become more difficult to obtain financing for larger ticket items such as autos or furniture — or any other type of revolving account after walking away from a mortgage or short selling..
- Waiting Period Before Buying Another Home – Depending upon other credit information, it typically takes 2 to 3 years after a short sale to obtain another home loan. After a foreclosure, it typically takes 5 to 7 years to obtain another home loan.
Tax Issues – The general rule is that where a lender forgives part or all of a debt, the amount cancelled is taxable income to the borrower. Because of Arizona’s anti-deficiency laws, most of the time the homeowner will not be liable for a deficiency judgment, thus resulting in cancellation of debt. Therefore, unless an exception to this general rule applies, the homeowner faces a potentially large tax bill when walking away or short selling. Fortunately, a few years ago, Congress passed a law which would exempt most homeowners from this tax liability. It is important to note, however, that this law applies only to a primary residence and to mortgage proceeds that were used to purchase or improve the home. Even more importantly, this law expires on December 31, 2012, so if it is not extended and/or another exception to this general rule does not apply (such as bankruptcy or insolvency), the potential exists that even though homeowners may not face liability to their prior lender for a deficiency, they may owe a substantial amount of taxes to the government. It is strongly recommended that homeowners consult a tax professional to review the tax implications in the event a strategic default is contemplated.
Homeowners Association Dues/Condominium Common Charges – If the residence is part of a homeowners association or condominium project, the homeowner is responsible for paying dues or other common charges and these dues and charges remain the personal obligation of the homeowner until the foreclosure or short sale takes place. Thus, if not paid, the homeowner faces liability for a judgment for the amount that is owed.
Set-off rights – Many people are not aware that if they default on a loan, such as a mortgage loan, and they also have a checking or savings account with the same lender, the bank has the right, without any notice to them, to take money from the bank account and apply these funds to the outstanding loan. This so called “set-off right” applies in situations where the homeowner stops making his mortgage payments. Thus, the homeowner should strongly consider moving his funds from any bank accounts that he has with his mortgage lender in order to avoid a possible set-off.
Nagle Law Group’s experienced residential real estate team has been practicing real estate law for over 20 years. Stuart Pack is a partner with Nagle Law Group, P.C., focusing on residential transactional and debt management matters, and can be reached at 602-595-3156 or stuart.pack@naglelaw.com.