Options When Facing Mortgage Foreclosure

Once foreclosure is inevitable, the defaulting homeowner still has options. Just packing up and leaving is not a good decision. The bank or other lender may sell the property of the defaulting borrower at a foreclosure sale. And, depending on the state, the lender may still be able to pursue the borrower for any unpaid balance remaining on the defaulting homeowner's loan after applying the proceeds of the sale. In another words, in most states the lender can still sue the borrower for the "deficiency". The homeowner might not have enough additional assets for it to be worthwhile for the lender to go to court and get a "deficiency judgment" against the defaulting borrower. But, by just walking away and giving up the property, the homeowner is exposing himself to more headaches.

Considering a Short Sale

In a short sale, the house is sold for less than the remaining obligation on the mortgage or loan. As with walking away from the mortgage and allowing the bank to foreclose, if the homeowner does this without prior bank approval, the borrower will probably still remain liable to the bank for any amounts remaining on the loan. Most states let the bank get a deficiency judgment against the borrower after a short sale. So, for the homeowner to sell short without bank approval, is essentially as bad as simply defaulting. However, the homeowner may be able to get the bank to forgive any remaining balance on the loan. In that case, the bank is approving the homeowner's short sale, absorbing any loss, and releasing the homeowner from any future liability. The downside of a bank-approved short sale is that, in terms of taxes, to the extent the loan is forgiven, the difference will be considered as taxable income by the IRS. 

Filing for Bankruptcy

Debts such as deficiencies and taxes from the foreclosure are discharged in bankruptcy. However, though a powerful tool for getting a fresh start from debt, filing for bankruptcy can have drastic consequences.

  • In a Chapter 7 bankruptcy, most of the homeowner's assets will be liquidated for creditors.
  • In a Chapter 13 bankruptcy, the homeowner will have to live under a court-ordered budget.

When facing foreclosure, it is best for the defaulting homeowner to consult with a real estate or bankruptcy attorney to discuss the best option based on the borrower's financial situation.