Many people these days have to, or choose to, go through the foreclosure process. A common question is whether bankruptcy is needed also. In short, the answer is “Yes,” as I’ll explain.
There can be many reasons for a foreclosure. Of course, due to a loss of income for any reason, or a jump in the mortgage payments, it may just not be possible to keep a house. BUT, more and more these days, people “decide” to let a house go in foreclosure.
It might be that the house is simply not worth anywhere near what’s owed on it (so why pay more for a house than what it’s worth?). This also causes a problem if you plan on moving in the next even 5 – 10 years (who will buy the house for enough to pay off the mortgage?). In addition, what if a major repair is needed? Where will that money come from? And renting may be a cheaper alternative, when you don’t have to think about taxes, insurance, repairs and upkeep. This “decision” to let a house go is so common these days, there’s even a phrase for it: A “Strategic Default.”
The idea is that there is a strategy behind this decision. These include all the factors I just mentioned in the last paragraph, plus a very important one: It can take 2 – 3 years for a mortgage company to go through the entire process of a foreclosure, and the house is still your’s in the meantime. Why move and start paying to live somewhere else now, when you have a free place to stay for awhile? Just “keep the lights” on is what I advise in these situations. And you’re not taking advantage. The mortgage company will eventually own the house and put a realtor’s sign out front to sell it. It’s a lot easier to sell a house than has NOT been vacant for 2 or 3 years. By just staying there, you are doing the company a favor.
Most importantly, it gives you a chance to save up some money with which to move, or live on in the meantime, until your income picks back up.
There are many steps to a foreclosure, and I often tell clients (even after their bankruptcy case is completely over), to show me what they’ve received, and I can advise them how much longer they have that they could stay in the house. Often, of course, by the time a foreclosure has even started, or is nearing the end, a client will have already found another place to live.
Why is bankruptcy needed in addition to just letting the house go? Because the amount the mortgage company sells the house for is rarely the same as what it is owed, especially after adding on all the costs and interest which has built up. That “left over” amount is called the deficiency, and I’ve seen lawsuits against individuals for $100,000 or so, well after the foreclosure. Filing bankruptcy – before or after the foreclosure – the timing is really up to you, prevents that.
Another reason is to avoid getting a 1099-C which can have a big impact on taxes you owe the IRS. This one is a little harder to explain, or just comprehend, sometimes. Let’s say you owed a credit card $10,000, and they agreed to settle the whole thing for $4,000. Assuming you were able to pay the $4,000 all at once, the credit card company is required by the IRS to file a 1099 for “forgiveness of debt” on the $6,000 you did not have to pay back. The IRS treats this as income to you, and it increases your tax bill. It seems strange: you think, “income? I just PAID money.”
Of course, in a mortgage situation, it’s usually a much bigger amount. If the house is eventually sold for $100,000 less than what was owed on it, and you get a 1099 for $100,000, you could easily owe the IRS $30,000 or so in income taxes.
These are the two most common reasons a bankruptcy is needed, to prevent the lawsuit on the deficiency, and to avoid a 1099 problem. In addition, many people are in debt in other ways because, perhaps, they were borrowing money on credit cards to try to keep up with the house payments before they stopped.
And one follow up. Filing bankruptcy early on in the process does NOT speed up the foreclosure. Many people file the bankruptcy (which essentially erases their name off of any “money” obligation) well before a foreclosure has even started. Their bankruptcy case is often wrapped up well before they even move out. Of course, I always continue to advise my clients about this part, and the timing, even after their case is done.