The Law you Should Know
Before you consider a short sale or foreclosure, here is the law you should know.
First, there are two types of debts. They are unsecured and secured. Unsecured debt is the bare promise to pay. The most common form is credit card debt. Secured debt, on the other hand, has two parts. The first part is the bare promise to pay which on a car loan or real estate loan is the Promissory Note. What makes secured debt different than unsecured debt is the security given by the borrower to ensure the promise is kept. This security on real property is called a Deed of Trust.
Second, on real estate loans, there are two different types of promises to pay. Non-Recourse or Recourse. A Non-recourse loans is (1) the loan or loans obtained to purchase a 1-4 unit property in which the borrower occupies at least one unit or (2) seller carry back. Everything else is recourse debt i.e. the refinance of the real property, lines of credit, the loan or loans used to purchase a rental property.
Third, personal liability depends on whether you do a short sale or foreclosure and whether you have a non-recourse or recourse debt. If you do a short sale, you can have personal liability unless it is waived by the lender. Effective January 1, 2011, on a first deed of trust on a 1-4 unit property, the lender should be agreeing to waive any deficiency in a short sale in accordance with SB 931, but you will need to make sure the correct language is in the settlement letter. If a property is foreclosed in a non-judicial trustee sale, you will not have any personal liability as to the loan that is foreclosed on because California is an anti-deficiency state i.e. the lender waives its right to come after you on the loan that they foreclosed on. However, if there are junior liens to the foreclosing lien, they will have the right to sue you after the foreclosure if the junior lien(s) are recourse loans. These loans are called “sold out” junior i.e. they lost their lien, but they still have the promise to pay and thus have the right to sue you on the promissory note.
Fourth, in every short sale or foreclosure, there are tax implications. The IRS wants to know two things. (1) Did you make any money on the deal and (2) Did you borrow any money which was not repaid. If you made money on the deal including taking out cash to buy another house, buy a car, pay off credit card, you may have gain. If you borrowed money which is not repaid either through a short sale or foreclosure, you may Cancellation of Debt Income (“CODI”). There are exceptions to the CODI, but you should “know” not “think” the tax implications before a short sale or foreclosure.
In conclusion, a short sale or foreclosure without legal advice is like jumping into the middle of the ocean with no life vest. Don’t do it. A short sale or foreclosure can stay on a credit up to 7 years. Do not take on liability which could have been eliminated or reduced with first obtaining legal advice.
Help is available to you. I see people every day for consultations on short sales and foreclosures for a flat fee of $300. If you end up needing to filing bankruptcy, the fee is a credit against the bankruptcy fees.
WE ARE A DEBT RELIEF AGENCY. WE HELP PEOPLE FILE BANKRUPTCY RELIEF UNDER THE BANKRUPTCY CODE. THIS INFORMATION IS NOT PROVIDED AS LEGAL ADVICE AND SHOULD NOT BE RELIED UPON IN MAKING ANY DECISION REGARDING A SHORT SALE OR FORECLOSURE. THIS INFORMATION IS NOT A SUBSTITUTE FOR OBTAINING TAX & LEGAL ADVICE REGARDING AN INDIVIDUAL SITUATION.