As a Real Estate and Foreclosure attorney, many homeowners ask me, what are the ramifications of foreclosure? These are typically clients who either owe much more on their property than it’s worth, or are in a property that has simply become unaffordable due to a mortgage rate adjustment or interest only term reset. They have decided that it’s time to move on from a bad real estate investment situation, but don’t want anything bad happening that will affect their future. In answering their questions, I usually review the ramifications of foreclosure as well as the advantages and disadvantages of short sale as an alternative. There are three main disadvantages or ramifications to a foreclosure: potential for a lawsuit from the lender for a “deficiency,” damage to the homeowners credit, and potential tax issues. There may be ways to negotiate or eliminate each of these issues by working with the lender or lenders.
Potential for Lawsuit: Some states, such as California, have “anti-deficiency” or “one-action” laws in place to protect borrowers from foreclosing lenders. This means that a lender who forecloses on a consumers property can not also sue for money damages, so long as they go through the non-judicial foreclosure process. These laws offer excellent protection when a borrower only has one mortgage (a first mortgage) but no second or third mortgages. The problem arises when a borrower also has a second mortgage, that lender will have not taken any “action” if the first mortgage forecloses and therefore may still sue the borrower for money damages. This can be negotiated however, a lawsuit does not have to be the result.
Damage to the Homeowners Credit: Foreclosure is obviously damaging to a borrower’s credit score as anytime a lender or creditor is not being paid, they report negatively to the credit bureaus. Additionally, the foreclosure itself (through county records) typically will also appear on the homeowner’s credit further damaging the credit or fico score. Although some damage is unavoidable, a homeowner who wishes to minimize the credit damage can do so by going through the short sale process with a qualified real estate and foreclosure attorney to protect their interests and minimize the ramifications of foreclosure.
Potential Tax Ramifications: The good news for homeowners facing foreclosure is that there typically are not huge negative tax consequences or ramifications from either foreclosure or short sale when the homeowner is “insolvent” at the time of the sale. It is tricky and difficult to give general tax information that is applicable to all borrowers as everyone’s tax situation is different, but most homeowners do not get left with a large tax bill as long as the situation is managed by an experienced real estate and foreclosure attorney or accountant.
As a general matter, homeowners usually come out of foreclosure better off with a short sale, as long as it’s done properly by an experienced attorney. There can be many negative consequences or ramifications of foreclosure that should be avoided whenever possible, a few of which have been discussed above. Foreclosure is a delicate situation which requires expertise beyond what can be learned by searching the internet. It’s something most people will only go through once in their life and it is important to protect your interests so as not to be sued later on.