- Review how a short sale can affect a second mortgage balance.
- Examine the tax implications of a short sale.
- Negotiate with the mortgage holder, if the loan becomes an unsecured loan.
Our deficiency balance for our first mortgage was forgiven. Our equity line of credit was not. Is this legal? Is so, now what?
We short sold our California house at the end of 2008. We had an equity line of credit on the house and got a 1099-C from the bank for that tax year. At this time we are getting bills from a creditor company on that equity line of credit amount. Our bank sold this line to a creditor after we short sale our house. When I checked our credit report a few days ago, it was stuck showing as a balance on our credit report. What should we do at this time? Are they allowed to bill us after we short sale a house?
Editor's note: The California legislature has changed the deficiency balance law twice since this was written originally. See the notes below to learn more about the changes to Calif. Civil Procedure §580e.
It appears the 1099-C you received was for the short-sale of the home and included the first mortgage (deed of trust), and not the equity line of credit. Each state has its own laws regarding collection of deficiency balances on home sales.
If the property was your primary residence, you are almost certainly subject to the Mortgage Forgiveness Debt Relief Act, which as its name implies, erases the taxes related to forgiven mortgage debt.
In a short-sale, the property owner and lender may choose to do a short sale on the home to avoid foreclosure. In a short sale the lender agrees to accept less than the balance owed on the mortgage at the time of sale. The deficiency balance is forgiven, typically, although there are no hard-and-fast rules in this regard. However, this does not always apply to the second mortgage or line of credit.
Some mortgage companies are asking borrowers to agree to accept liability for the deficiency balance. The lesson here is if you are considering either a deed-in-lieu-of-foreclosure or a short sale you must review the terms and conditions carefully and make certain you understand whether the deficiency balance is forgiven.
Deficiency Balance in a Foreclosure
A deficiency balance arises if the sale proceeds are not sufficient to pay the entire balance owed on all secured loans. The consumer may be liable for the difference. Some lenders may forgive a deficiency balance, but not all do. California consumers who default are protected, in some cases, by the state’s anti-deficiency laws. In California, if a consumer has not refinanced a purchase money loan, then the creditor for the first mortgage (called a deed of trust in California) may not sue for the deficiency balance. However, line of credit loans and non-purchase money second mortgages (deeds of trust) are not covered by California’s anti-deficiency laws.
Suing for a Deficiency Balance
Generally speaking, it is unsound economically for an original creditor to sue for the deficiency because the debtor usually does not have the financial resources. After all the debtor would not have defaulted if they could have afforded the payments, in most cases.
Original creditors rarely choose to litigate a deficiency balance case. Instead, the original creditor will sell (also called assign) a deficiency balance account to a collection agent. Typically, unsecured debts such as deficiency balances, credit card debt, medical bills, and payday loans are sold for pennies on the dollar. Despite the bargain-basement price of a collection account, a collection agent had the legal right to collect the face value of the account. If a creditor files a lawsuit and wins, it may be able to obtain a judgment, which could lead to wage garnishment, bank levies, and/or property liens, depending on the defendant’s state laws.
Consult with an attorney in your state to determine if the creditor has the right sue you in your circumstances, and if so, what the consequences may be. You mentioned you reside in California. See the Bills.com resource California Collection Laws to learn more about your rights and potential liabilities. Editor’s note: California SB 931, which was signed into law September 30, 2010 and became effective January 1, 2011, outlaws a deficiency judgment under a note secured by a first deed of trust or first mortgage for a short sale. SB 458, signed by the governor July 11, 2011, forgives all debt, including second mortgages and deeds of trust, after a short sale. A lender may not require a homeowner to waive these rights contractually.
Following the foreclosure, the second mortgage or line of credit became an unsecured debt. Negotiate with the creditor in an attempt to reach an out-of-court settlement on the debt. If necessary, enroll the debt in a debt negotiation program. (Go to the Bills.com debt relief savings center for a no-cost quote.) Another option is to negotiate the debt yourself. Consider offering the creditor 10 cents on the dollar for a lump-sum settlement.
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