Debt Forgiveness on Lines of Credit

The Loan Balance is Gone…. Really?

I have received many calls in the past month from borrowers who have received letters from their mortgage lenders stating that the lender is going to forgive the balance on their line of credit in the next 30 days if the borrower does not call to decline the offer.  Yes, you read that right.  No strings attached.  The balance on the loan will be gone.

So who is doing this?   So far, most of the letters have been coming from Bank of America and Chase.  However, given the requirements of the National Mortgage Settlement, I think we can expect to see the letters from all the Big Five i.e. Ally Financial, Inc. formerly GMAC Mortgage, Residential Capital, Bank of America,  f/k/a Countrywide Home Loans Servicing, Citigroup, Citibank, CitiMortgage, JPMorgan Chase and Wells Fargo Bank.

So, what is the catch?  The catch is that when the debt is forgiven, a 1099c is going to be sent to the borrower for the amount forgiven.  What this means is that amount forgiven is going to be considered income at your current tax rate unless one of the exceptions to the income recognition rule applies.

So what are the exceptions? 

#1- The borrower filed bankruptcy before the debt is forgiven.  The bankruptcy does not have to be finished, but it does have to be filed prior to the end of the 30 days.

#2- The borrower is insolvent.  What this means is that the borrowers does not have assets such as 401k/IRA/pension benefits or other assets.  Many a person has believed themselves to be insolvent only to be informed that those assets they cannot currently reach are still assets for determining solvency.   If you think you are insolvent, be sure to talk to your tax advisor within the 30 day period to confirm.

#3 The Debt being forgiven falls under business debt exception

#4 The Debt being forgiven falls under the farm debt exception.

#5 The Debt being forgiven was one of the original loans used to purchase the home.

#6 You fall under the short sale and mortgage forgiveness act which is still in effect until January 1, 2013 which provides that to the extent the money was used to purchase the property or make significant improvements to the property and it has been your home for the last 2 of 5 years, you do not owe taxes

In conclusion, if you receive one of these letters, I recommend you seek legal counsel immediately to determine whether this offer is in your best interest.  This is a complicated area of the law.  A real estate or bankruptcy attorney should be able to make to an analysis of your situation quickly which will allow you to decide if the debt forgiveness is in your best interest.

I see people for a FREE 30 minute consultation at my offices in Walnut Creek and Brentwood.

Advice From People Who Filed Bankruptcy

 I have been asking people who come into my office if they have any advice/regrets about their actions prior to filing bankruptcy.  Here is their advice:

1. Seek Legal Counsel.  Don’t wait to find out your options.  Almost every person said they wish they had come in sooner.  Many have said they would have done things differently had they known the law and available options.

2. Don’t borrow or take money from your 401k, IRA, Savings Account, Children’s Saving Account, Deferred Compensation to cure to the default.  So many people regret borrowing or taking a distribution from their retirement plan.  Unfortunately, many people don’t know that this money, if borrowed, must be repaid in full or it will be considered income and taxed accordingly.  In addition, this tax cannot be discharge in bankruptcy.  It is heart breaking to see people take money out of their retirement to stay current on the mortgage, to only lose the house at the later time, but are still responsible for tax liability of the distribution.  

3. Don’t borrow money from family or friends to stay current on mortgage or other bills.    Family and friends want/expect to be repaid irrespective of whether you file bankruptcy.   In the eyes of the bankruptcy code, your family and friends are just another lender and will not receive preferential treatment.  

4. Don’t juggle credit cards to pay mortgage.  Cash advances and balance transfers may cause problems in a bankruptcy.  In addition, depending on the type of real estate debt you have, a short sale or foreclosure may be possible without a bankruptcy.  However, if you run up your credit cards trying to keep the house, a bankruptcy may be evitable.

5.  Don’t leave house until property forecloses or short sale is complete.  Almost every person that has left their home prior to the foreclosure or short sale being completed regrets the decision.  Once you stop paying on the mortgage, your rent is “free” with the exception of paying the Homeowners Dues and keeping insurance on the property.  Further, since you are still responsible for the maintenanceof the property until the foreclosure or short sale, you might as well enjoy it and save some money.  No reason to pay rent any soon than necessary.

6.  Don’t let your cultural pride stand in the way of you making sound financial decisions.  There is nothing to be ashamed of.  You did not make this economic meltdown.  You are not responsible for the economic collapse facing the Bay Area.  The economy of your parents’ generation is not the same as today.   

7.  Don’t co-sign for anyone.  No one can promise the future.  So many clients regret co-signing for a friend or relative. Co-signing for cars, furniture, Time-Shares and homes seemed like a good idea, but times change and suddenly there is a default.  Worst of all, don’t co-sign on Student Loans.  The defaultrate by students who have had a friend or family member co-sign is much higher and YOU CANNOT DISCHARGE CO-SIGNED STUDENT LOANS IN BANKRUPTCY!

If you do not have sufficient income to pay your bills as they come due and owing, you should seek legal counsel before withdrawing any monies from a retirement account, savings account or taking a loan against your home or car.  These are difficult times, but do not miss the help and protection provided by the Bankruptcy Code and California law by waiting too long.  Just because this ship is underwater does not mean that you should give up your life vests that you will need to keep you afloat!