Banks slow to foreclose, More than meets the eye?
Banks slow to foreclose, More than meets the eye
?More than 25% of homeowners are underwater nationwide. In states like California, Arizona and Nevada the statistics are much worse. It is estimated that in Nevada alone more than 70% of home mortgages are underwater. One of the main solutions used by underwater homeowners is Strategic Default.
According to Wikipedia a strategic default is the decision by a borrower to stop making payments (i.e., to default) on a debt despite having the financial ability to make the payments. This is particularly associated with residential and commercial mortgages, in which case it usually occurs after a substantial drop in the houses pricesuch that the debt owed is (considerably) greater than the value of the property the property has negative equityor is "underwater" and is expected to remain so for the foreseeable future, such as following the bursting of a real estate bubble. Such borrowers are called "walkaways".
The problem with a strategic default is the fact that when debt is forgiven (i.e. for any reason you do not have to pay a debt), the IRS considers the debt forgiveness to be taxable income. Realizing that this standard IRS rule would require many homeowners who lost their homes through foreclosure to incur hefty tax consequences, Congress enacted The Mortgage Forgiveness Debt Relief Act of 2007 (the Act).
Basically the Act allows taxpayers to exclude from income any debt forgiveness or discharge of debt related to their principal residence. Debt reduced through mortgage restructuring (principal write downs), as well as mortgage debt forgiven in connection with a foreclosure qualifies. The Act applies ONLY to debt forgiven between the years of 2007 through 2012. The exclusion only applies to taxpayers who had a decline in their home's value or a decline in the taxpayer's financial condition. Additionally, the exclusion only applies to proceeds used to purchase or remodel a home, any home proceeds used for other purchases such as vacations cars etc are not included in the Act and therefore may be taxable if forgiven.
The issue with The Mortgage Forgiveness Debt Relief Act of 2007 is the fact that it expires December 31, 2012. Congress will most likely not extend the Act.
If you live in a non-recourse state, one of the easiest ways to recover financially is using strategic default. You voluntarily allow the bank foreclosure upon your mortgage and live in the house rent free for as long as possible. The homeowner can then save the money not spent on house payments or rent to make them whole again. The longer you can stay in the house without payments the better your financial condition will be.
The foreclosure timeline varies widely depending upon the state you live in and the type of foreclosure sought, whether judicial or non judicial. In some states it may take more than 2 years to foreclosure upon a mortgage. Here is where the problem lies. If you decide to seek a strategic default and stop making your payment January 2011, you have only 24 months for the bank to complete the foreclosure process. January 1, 2013 the Mortgage Forgiveness Debt Relief Act of 2007 expires and any debt forgiven after this debt will once again become taxable income.
The banks and other financial institutions are well aware of this date, and starting in January 2012 the banks will stretch out foreclosures. Nearing December 2012, the banks will try and push all foreclosure into 2013, knowing that bank can then 1099 the homeowners and make the homeowner pay taxes on the difference between what the home finally sells for and the actual mortgage balance. The banks will view the tax consequences as leverage against the defaulting homeowner, to cure the default.
So how stiff the tax consequence can be really depends on your own specific situation? The example below illustrates a house that sells for $100,000 with a $200,000 mortgage, assuming a 35% federal tax bracket. State taxes may be due as well.
$ 200,000 Mortgage balance
-$ 100,000 Final sales price
=$ 100,000 Debt forgiveness
X .35 Tax rate
$ 35,000 Federal tax liability
Having to pay federal and state taxes on foreclosed homes will just add insult to injury to many taxpayers. If you are seriously considering a strategic default, the time to investigate your options and make your choice is now. Otherwise, the same choice may incur hefty tax consequences in the near future.