Before owning a home, many of us think of it as a simple process: find the home of our dreams, get a loan, buy the house, pay the mortgage, live happily ever after. But as many homeowners have found, this process can get very complicated, very quickly. If the housing market is struggling and the economy is doing poorly, it can become difficult to pay your mortgage or sell your home. Because of this, many people have lost their homes to foreclosure in recent years.
However, there are alternatives that every homeowner should explore before turning to foreclosure, and one such alternative is the pre-foreclosure sale. A pre-foreclosure sale occurs between the time that your lender initiates the foreclosure process due to your defaulted loan and the time of the foreclosure sale. During this period, you still legally own the home and can try to sell it to satisfy your outstanding debt and avoid foreclosure.
What Is Foreclosure?
To understand the pre-foreclosure sale, it helps to first know what foreclosure is and why you should try to avoid it. When you fall behind or “default” on your mortgage payments, your mortgage holder can gain ownership of the property and sell it in order to pay off the debt. If the sale doesn’t cover what you owe, the lender may be able to sue you for the difference. Additionally, a foreclosure causes significant damage to your credit score, making it difficult to borrow money in the future.
How Does a Pre-Foreclosure Sale Work?
One option used to avoid foreclosure is the pre-foreclosure sale. Once you’re behind on your payments, your lender can initiate the pre-foreclosure process by sending you notice that you risk losing your home if you don’t bring your account current again. You may be able to negotiate a payment plan or loan modification, or apply for forbearance, among other options.
If you decide that you can’t keep your house, the pre-foreclosure sale allows the defaulting homeowner to satisfy their debt by selling the property. If the home sells for less than what is owed on the mortgage, it is a “short sale.” In order to have this sale satisfy your debt in full, the lender must agree to the sale and to forgive the remaining balance on your mortgage. Otherwise, you will still be responsible for the amount over and above the sale price of the house. This option allows you to avoid foreclosure and many of its detrimental consequences.
Tax Implications for a Pre-Foreclosure Sale
Unfortunately, there are some unpleasant costs associated with a pre-foreclosure sale. The first is obvious: you’ve lost your home and need to find new housing. If your credit took a hit from your late mortgage payments or other past-due bills, securing a loan for a new home may be difficult (though not as difficult as foreclosure would have made it). Additionally, many landlords use credit reports to assess whether you’re reliable enough to pay rent on time, so it could hinder your search for a rental as well.
Another significant consequence of a pre-foreclosure sale is the tax bill Uncle Sam might send you. Generally, if you owe a debt to someone and they cancel or forgive all or part of that debt, you have to report the forgiven amount as income on your taxes. Therefore, if you owe $200,000 on your mortgage and the pre-foreclosure sale price on your house is $150,000, but the lender forgives the remaining $50,000, you have to report that $50,000 as taxable income. However, there are exceptions to this rule, including bankruptcy, insolvency, and the Mortgage Forgiveness Debt Relief Act.
Buying a House in a Pre-foreclosure Sale
If you’re thinking of buying a house in a pre-foreclosure sale, you may get a good deal, but you should do your research and understand the timeline. Since the owner is usually still living in the house and is probably considering all of their pre-foreclosure options, the process may take extra time. And if the house is worth less than what the owner owes on it, their mortgage holder will have to approve the sale. Conversely, the lender may actually be close to foreclosing on the property altogether, shortening your timeline. In addition to these considerations, you, your attorney, or real estate company will need to research market values, consider all the costs and fees, and make sure there are no other liens against the property.
Make an Informed Decision About Your Pre-Foreclosure Options
The prospect of losing your home and significantly damaging your credit in foreclosure can be overwhelming. But it’s a scenario that many homeowners face, especially when the job market is hurting and house prices have dropped. To help make an informed decision about your home, contact an attorney experienced in foreclosure and pre-foreclosure alternatives.