Even states with anti-deficiency laws often do not protect a borrower from liability for a second mortgage following foreclosure. For example, Oregon and Washington are often referred to as “non-recourse” states, but there is no protection in place for those homeowners who completely financed their property with one of the ever-so-popular 80/20 deals of the past from having to pay back that second, 20% loan. All too often previous homeowners attempt to obtain some type of financing only to find out that their second mortgage account is still reporting to the bureaus. And, unfortunately, it’s a legitimate debt.
In a normal environment, after a property is foreclosed any proceeds from the sale will go to pay off the first mortgage first and any remaining funds would go towards the second mortgage. Nowadays, most foreclosed properties are underwater; often leaving the second mortgage holder high and dry.
Lenders of recourse loans (loans for which there are no state laws to deem any remainder uncollectable) have three choices: write off any remaining debt as a loss, sell it to a third party debt collector or pursue a deficiency judgment. Based on our experience, deficiency judgments are very rare. However, there is no way to predict how a lender will proceed. The deficiency judgments we have seen have been pursued against borrowers in a wide variety of financial situations.
If the lender pursues the remaining debt:
You will be personally served a Complaint and Summons. This is the initiation of a formal civil suit seeking a judgment for the amount of the principal balance, fees accrued and costs incurred to the lender during the foreclosure process. If this judgment is obtained, the debt collector may have the ability to place liens on the borrower’s property, garnish wages and/or levy their consumer accounts. In the event that the Defendant(s) cannot be found for personal service, most courts will allow for service by publication and/or mail. This is why it is a good idea to keep your mailing address updated with all entities involved in the foreclosure. You want to be aware of all action involving the property, foreclosure and any remaining debt.
In our experience, it is more likely that a lender will pursue home equity line of credit (HELOC) accounts than purchase money loans. Also, we have seen more suits from Citibank, Wells Fargo and small banks and credit unions than other lenders.
Again, there is no way to predict whether or not a lender will eventually file suit – especially in states with longer statutes of limitations (the timeframe in which a lender can pursue the debt according to state law). The good news is that we have seen accounts settled even after a suit has been filed. Depending on their individual situation, some may also consider bankruptcy if they are facing a significant judgment.
If the lender sells the debt to a debt collector:
You will become subject to common collection tactics. This can include phone calls, account statements, demands for payments and requests to settle the account. After a foreclosure, any remaining debt is no longer secured by the property. It is essentially the same as credit card debt. Debt collectors often purchase these accounts at a significant discount and, as a result, we typically see these accounts settled for around 10-20% of the account balance. But again, there is no way to predict what will happen in a particular situation.
What to do?
Most people begin negotiations simply by contacting the original lender or running their credit to see where the debt has been transferred. The Fair Debt Collection Practices Act states that within five days after the initial communication with a consumer in connection with the collection of any debt, a debt collector is supposed to send the consumer a written notice containing:
1) the amount of the debt;
2) the name of the creditor to whom the debt is owed;
3) a statement that unless the consumer, within thirty days after receipt of the notice, disputes the validity of the debt, or any portion thereof, the debt will be assumed to be valid by the debt collector;
4) a statement that if the consumer notifies the debt collector in writing within the thirty-day period that the debt, or any portion thereof, is disputed, the debt collector will obtain verification of the debt or a copy of a judgment against the consumer and a copy of such verification or judgment will be mailed to the consumer by the debt collector; and
5) a statement that, upon the consumer’s written request within the thirty-day period, the debt collector will provide the consumer with the name and address of the original creditor, if different from the current creditor.
If you disagree with the amount owed, or would otherwise like to validate the debt you should request verification in writing. The Act states that if the consumer notifies the debt collector in writing within the thirty-day period that the debt, or any portion thereof, is disputed, or that the consumer requests the name and address of the original creditor, the debt collector shall cease collection of the debt, or any disputed portion thereof, until the debt collector obtains verification of the debt or any copy of a judgment, or the name and address of the original creditor, and a copy of such verification or judgment, or name and address of the original creditor, is mailed to the consumer by the debt collector.
Once the debt has been verified, you can simply offer a lump sum amount or request a payment plan. Based on borrower feedback, collectors are usually non-threatening, but do not be intimidated if you encounter an overzealous collector. These are people who often make commission based on the amount of debt collected. You may wish to review the Fair Debt Collection Practices Act so that you are aware of your rights and what constitutes illegal collection activity prior to initiating settlement negotiations. Most borrowers offer 5-10% to begin with. You can offer whatever you are comfortable with or have access to. Normally, collectors are fairly cooperative when the borrower exhibits willingness to come to some type of resolution.
If you cannot or do not wish to settle the debt and are subject to harassing collection calls, you may wish to send the collector a cease and desist letter. Once on file, the collector can only call for very specific reasons.
No matter what, if you are trying to deal with this so you can purchase a new home after foreclosure, you need to get a letter from the creditor. The letter must state specifically
1. That your account is closed
2. You no longer have a balance or any past due amounts owed.
3. The letter must be on the lenders letter head and state your name and account number. Make sure it matches up with the account number on your credit report.
4. Give this letter to a mortgage professional who can do a “Rapid Rescore” and update the credit bureaus within 3-5 business days. Be prepared to pay around $35 per bureau to get the rapid rescore done. This is paid directly to the credit report company and not the loan officer or broker / lender.
If the lender writes off the debt as a loss:
You are released from legal responsibility for repayment of the debt and will receive a 1099-C in the January following the year in which the debt was cancelled. Under normal circumstances cancelled debt is considered taxable income for borrowers. In 2007, the Mortgage Forgiveness Debt Relief Act was passed. This excludes from taxation discharges of up to $2 million of indebtedness that is secured by a principal residence and was incurred as a result of the acquisition, construction or substantial improvement of the property. This means that homeowners who foreclosed on a principal residence and have never refinanced by taking out a home equity line of credit are not responsible for taxes on the difference between the loan balance and the amount the property is sold at auction. This Act was extended through 2013 as part of the ‘fiscal cliff’ negotiations.Tweet