Consequences of Foreclosure

Aparna Iyer Jan 27, 2019
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Foreclosures are result of homeowners being unable to discharge mortgage dues, due to various reasons. Getting laid off, illness, or bad investments may cause people being unable to fulfill mortgage obligations. Here is an examination of foreclosure consequences.
For most people, foreclosures are the result of not anticipating the downturn in the housing market. The belief that home prices always appreciate, led people to borrow huge amounts of money to buy a home.
Since most of the borrowers were subprime, as soon as interest rates started appreciating, they found themselves unable to make principal and interest payments. This, in turn, forced the lender to initiate foreclosure proceedings in order to recover the mortgage dues.

Counter Effects of Foreclosure

Renting

Once the foreclosure sale is complete, the erstwhile homeowners have no option but to look for alternate accommodation. Looking for rental accommodation may not be easy for people who have a foreclosure on their record. Prospective landlords may be unwilling to rent a house or a condo to tenants who in the past have been unable to repay their debts.

Credit Impact

The credit score invariably takes a hit on account of foreclosure. The credit score can fall by as much as 300 to 400 points. A foreclosure makes the credit history averse and negatively impacts a person's eligibility for various loans in the ways as described further.
Credit Cards: Credit card companies may increase the annual percentage rate (APR) on existing credit cards after a foreclosure. People may find it difficult to sign up for low interest rate credit cards that may help them rebuild their credit scores.
Mortgage Loans: Seeking a home loan after a foreclosure is another issue. Both Freddie Mac and Fannie Mae have increased the waiting period for seeking conventional mortgage loans after a foreclosure sale to five years. FHA (Federal Housing Administration) and VA (Veterans Affairs) insured loans can be sought three years from the date of a foreclosure sale.
Car Loans: Getting a car loan is also difficult after a foreclosure. Dealers and banks are generally unwilling to lend to people who have found it difficult to keep up the mortgage payments on their house. Even if lenders are willing to provide a car loan, they may charge a very high rate of interest as compensation for the risk involved.
Manufactured Home Loans: Getting a bad credit manufactured home loan is not easy. If the borrower's credit score is less than 600 points, lenders would need up to 35% down payment for equity loans to make necessary improvements on the house. Hard money lenders may be willing to provide a loan for buying a manufactured home at very high rates of interest.

Taxes

Mortgage lenders may be willing to forgive or cancel a portion of the debt that they may not recover after foreclosure sales. However, unless the loan is a non-recourse loan or the borrower has declared bankruptcy or is insolvent, the amount of debt cancellation is taxable.
For recourse loans, taxes are calculated on debt cancellation income, which is difference between fair market value of the property under foreclosure, and amount of mortgage debt owed, assuming the difference is positive. Gain from foreclosure sale is taxable if the home has not been primary residence for at least two of the five years before foreclosure.
However, gains less than USD 250,000 (or USD 500,000 for married couples filing jointly) are exempt from taxes. For non-recourse loans, this gain is calculated as the difference between the mortgage debt prior to foreclosure and the purchase price of the home, including the cost of improvements.
For recourse loans, the difference between the fair market value of the property under foreclosure and the purchase price of the home including the cost of improvements is taxable. Keeping in mind the aforementioned consequences of foreclosure, the government has initiated debt relief and debt restructuring programs.

Government Help to Stop Foreclosures

The number of foreclosures that have been taking place since September 2007 have resulted in the government adopting measures in order to help people avoid impending foreclosures. Making Home Affordable Program and HOPE for Homeowners Program and are some of the positive initiatives taken by the government to help people avoid foreclosures.
Home Affordable Refinance Program (HARP) and Home Affordable Modification Program (HAMP) are a part of the Making Home Affordable Program. In fact, private mortgage lenders have also been encouraged to allow short sales as an alternative to foreclosure sales. Despite these measures, many people have been facing the brunt of foreclosures.