By: Ilyce Glink and Samuel Tamkin
In a recent column, we discussed an underwater homeowner’s options when dealing with the sale of their home. In an underwater loan, the homeowner owes more money to the lender than the home is worth. In response to the column, one of our readers sent us the following letter:
“In your recent newspaper article about “House is robbing homeowner of happiness” you left out two very, very important items, in my opinion. The very first thing that the person should do is rent an apartment or house in the same town or another state if they want to move since they have a job and presumably fair credit at least. After a rental is secured, they should walk away from the house. I can’t believe you suggested those other solutions. Why is abandoning the home the worst way to go? I see it in his/her circumstances as the best way to go by far. Next, on the short sale the person could be taxed on any money the bank lets them out of. We think they should rent and walk away.”
While we understand where our reader is coming from, we’d like to address some of the issues raised in her letter. Once critical piece of information is that if the homeowner sells the underwater home or if the home is foreclosed and the balance of the debt is released, the IRS presumes the homeowner would receive that release of debt as phantom income in both cases.
When a borrower takes a loan and fails to pay it back, the lender has the right to pursue that borrower for the debt. If the lender releases that debt, the borrower received the benefit of the loan and for federal income tax purposes, the release of the debt obligation is income to that homeowner.
Until the end of 2013, the IRS will not view the release of certain indebtedness for homeowners who lose their primary residence as income. That could change next year, but for now, our reader isn’t correct that going the short sale route would result in taxable income to the home seller and not if they simply walk away.
But there’s a bigger issue looming. Some lenders are not forgiving the debt. Here’s how that might work.
If the underwater home goes through foreclosure and the bank gets only $100,000 from the sale, the former owner might still owe the bank $100,000. If the borrower doesn’t get the lender to agree to release the debt, the borrower may find himself pursued by the lender or bill collectors for years to come. While some states prevent the lender from going after the borrower, other states permit the lender to go after the borrower long after the home has sold.
In the end, the borrower might end up having to file for bankruptcy to get rid of the debt. But, we feel it’s usually easier for a borrower to deal with a lender with a smaller debt than a larger amount owed. If you can minimize the losses from the sale, we think that is the better way to go.
Owners should also realize that their homes are their homes until title to that home transfers to the lender or a different buyer. They should know that if there is a problem with the home or someone is injured in the home and there is no insurance on the home, the person that abandoned the home might still have responsibility for what goes on in the home. The lender might put in place insurance, but if someone is hurt on the property and that person decides to file a lawsuit, the person named in the lawsuit will include the owner of the home.
If the owner has a job and has moved on, he or she might find out third-hand that he or she has been sued and will have to figure out what to do to respond to that lawsuit at that time.
We don’t believe that walking away is never an option. If a lender won’t agree to a short sale, won’t agree to a deed-in-lieu of foreclosure, can’t or won’t agree to a loan modification and the homeowner can’t afford the home or must move for a new job, the moving on might include walking away.
However, we feel that homeowners should work to solve their situation with the lender and use the solution presented by our reader as a last resort.