What Debt Am I Responsible for After a Foreclosure?

••• new house 66 image by Paul Moore from Fotolia.com

Foreclosure is the method by which a mortgage lender calls due its security interest in your real estate by seizing ownership of the property. Mortgage lenders typically foreclose on a home when the borrower stops making mortgage payments. Although foreclosure provides the lender with the loan’s collateral, allowing it to sell the property to recover unpaid mortgage debt, you may still owe debt to your lender and other creditors after the foreclosure takes place.

Mortgage Deficiency

When you signed your initial loan paperwork, you agreed to repay the lender whatever portion of your home’s purchase price you borrowed. If you lacked equity in your home or the property values in your area declined in the time since you obtained your mortgage, your lender may not be able to recoup your loan balance by selling your home.

If your lender receives less for the property than you owed on the mortgage, the difference constitutes a loan deficiency that you are responsible for paying off unless you live in a non-recourse state. Non-recourse states, such as California, do not allow lenders to pursue mortgage deficiencies after a foreclosure sale.

Tax Debt

If you owed a tax debt to the Internal Revenue Service (IRS), the IRS has the right to place a lien against all property that you own – including your home -- until you pay off the tax debt in full. If your mortgage lender subsequently forecloses on the property, the IRS will continue to pursue you for the tax debt that you owe.

In some cases, a foreclosure can actually cause a tax debt. Rather than pursuing a mortgage deficiency, your lender can opt to write off the debt as a business loss – resulting in the IRS requiring you to claim the forgiven loan value as income on your taxes. Although the Mortgage Forgiveness Debt Relief Act protects homeowners from this requirement, it does not apply to all consumers, and its protection will no longer be available after 2012.

Second Mortgage Debt

By taking out a second mortgage on your property, you owe a mortgage debt to two lenders rather than just one. Lien priority, however, states that the foreclosing creditor must pay off liens in the order they were attached to the property. Thus, if your primary mortgage lender forecloses, your second mortgage goes unpaid.

Once this occurs, the second mortgage – which was previously secured by your home – becomes an unsecured debt. The lender then has the option to sue you for payment. Depending on your state laws, this could give your second mortgage lender the right to garnish your wages and bank accounts.

Judgment Debts

After an unsecured creditor, such as a credit card company, sues you for an unpaid debt and wins a court judgment, it typically attaches a lien to property that you own. A foreclosure wipes away the judgment lien – but not the debt itself. Because the judgment creditor has already won a lawsuit against you, it can immediately petition the court for a garnishment order after losing its security interest in your property.