Q: My husband and I are contemplating allowing our rental property to go into foreclosure and desperately need your advice. When we married in 2010, we had three homes. We each had a house prior to being married, and I purchased the home in which we currently live. I was able to sell my former home, and we turned my husband’s home into a rental.
My husband purchased his home at a foreclosure in 2004 with two mortgages. We paid off the equity line. We hoped to ride the storm out and eventually sell the property once the market recovered. Long story short, this property is significantly upside-down. Although we understand that the market will eventually come back, we agree that the area in which the rental property is located will continue to trail the market.
Our renters recently relocated, and the home is currently empty but it needs much-needed improvements prior to re-renting, as the home is not safe. We are therefore considering allowing this home to go into foreclosure. Because it’s a rental, it’s difficult to find a lender willing to refinance the mortgage. Is there risk of the lender coming after me since the home is only in my husband’s name? Are there tax implications on our joint return?
A: Your letter is similar to many we have received from our readers over the last several years. Our readers are conflicted over the financial and moral issues associated with foreclosure. Our position is that buying real estate is a business deal: you agree to pay back the lender and if you don’t, the lender agrees to take back the home. We’ve raised the “moral” issue in prior columns and leave that particular issue to each homeowner.
The legal aspect of your question is that your husband obtained financing from a lender and signed a promissory note and a mortgage that went along with that deal. The note and mortgage obligate him to repay the debt to the lender. If he fails to pay that debt, the lender has the ability to foreclose on the property to satisfy as much of the debt as possible. If money is still owed after the foreclosure, the lender has the legal right to sue the borrower for the deficiency.
In the eyes of the law, if you break the agreement you made with the lender, the lender can exercise its rights to pursue you for its damages. Historically, most contracts have also had a moral obligation attached to them. The moral obligation was different from the legal obligation. If a person promised to do something, that person had the legal and the moral obligation to perform. The courts are there to punish people for legal offenses but not for moral failings.
Have you tried to refinance under the Home Affordable Refinance Program (HARP)? While most homeowners believe HARP is just for primary residences, there are lenders who offer HARP refinances to real estate investors. Find out more at MakingHomeAffordable.gov.
If you’re trying to avoid foreclosure, you might want to try a short sale. Lenders aren’t blind to the market realities. If your husband markets the property for sale and finds a buyer, he may find the lender willing to allow the sale to go forward.
The real issue for you is if you are successful in selling the home in a short sale, the lender may require you to pay the balance of what you owe them or could waive the deficiency. Alternatively, the bank could either set up a payment plan for you or give you a break and reduce the amount owed. It would be up to you (or your attorney, and we strongly suggest hiring one) to negotiate the best deal for yourself.
Given your desire to get out of the problem your husband is in, your best solution might be to reduce your losses, work out a deal with the lender and move on. Allowing the property to go into foreclosure may not help and could be worse for your husband. In foreclosure, the lender may get less than it otherwise would get if you sell the home. Yet, the lender may still have the ability to go after your husband for the deficiency.
Keep in mind that an aggressive lender can obtain a judgment against your husband and pursue him vigorously. They could garnish his wages, lien any property he might own (even property you own together), and could end up forcing him to file for bankruptcy.
On the last issue you raised relating to your husband’s tax situation, if the lender ends up waiving any of the deficiency – that is, excusing your husband from repaying the debt – the amount that the lender waives will be considered income to your husband. As income, your husband will have a federal income tax bill to pay on it. If the lender waives $100,000 of debt, your husband could be looking at a federal income tax bill of $25,000 on up on that relinquished debt.
Please consider all of these issues carefully before making a move. Several of these options could have costly outcomes. Good luck.