Foreclosure of Primary Residence – Options to Consider

If you start digging into the Foreclosure options you will see there are Judicial and Non-Judicial foreclosures and recourse and non-recourse states.  There are some reasons to consider letting your primary residence go into foreclosure even if you are not “bankrupt”.

First of all you need to know if your primary residence is in a non-recourse State.  The following are non-recourse States:

Alaska, Arizona, California, Connecticut, Florida, Idaho, Minnesota, North Carolina, North Dakota, Texas, Utah and Washington.

This means that if you only have one mortgage on your primary residence and that mortgage is higher than the value of your home and you decide to let your home go, the Bank cannot come after the difference between what you owe and what the home eventually sells for after the bank foreclosures.  Now, everyone, need to get legal advice on the personal situation because there could be other factors you would need to be aware of.  For instance, if you have refinanced your original mortgage – your new mortgage may now be a “Recourse” loan.  Borrowers have to take responsibility for reading all the fine print on every financial agreement (i.e. credit cards etc.) they make.

In addition, since the Mortgage Forgiveness of Debt Relief Act of 2007, you will not have to pay Federal tax on the “Forgiveness of Debt” (or Debt Cancelation) income on your primary residence if it is foreclosed on before 1/1/2010 (this will probably be extended) if it is under $2,000,000.  I said “Federal” because States with Income Tax have laws that vary from these terms and you have to look at it on a State by State basis.

Most individuals already qualify for the tax free primary residence exemption on the sale of their home anyway and when a home is foreclosed on it is looked at as selling your home for the amount of the loan that was forgiven.  Also, at this point, a lot of people paid more for their homes than the mortgage forgiven so they would actually have a loss on the foreclosure.  That loss is not deductible on a primary residence.

A common scenario is that people may have several hundred thousand in other assets other than their homes, but do not want to dip into these funds (typically retirement) to make payments on a home that is upside down and not likely to rebound any time soon.  So, if they are in a non-recourse state and meet all the qualifications of a primary residence with one mortgage – and do not care about their credit rating for some years to come – they will walk away from their home.  It can make good financial sense in some situations.

What Happens if you have  HELOC (Line of Credit) or Second Mortgage?   The proceeds from the sale of the home will have to cover those loans or you will most probably be held personally liable for paying those off.  They can come after all of your other assets except for retirement funds.  You need to retain good legal advice, again, before you make these moves.