Before you hand the keys to your lender, know the costs

Before you hand the keys to your lender, know the costs

Ilyce Glink
Real Estate Matters
November 17, 2011

Q. Let's say I stop paying my mortgage each month. And let's say there is some time before the house is foreclosed. Who continues to cover insurance, utilities and such? Also, what impact does a deed-in-lieu of foreclosure have on my credit rating?

A. You may be a bit confused about what a foreclosure is and how the process works.

Let's start at the top: You are responsible to pay your lender the amount you owe under your loan. You are also responsible for paying your property taxes, utility bills and insurance premiums.

If you stop paying your lender, your lender may decide to pay the homeowner's insurance premium and the real estate taxes due on the home. But it would be paying those expenses on your behalf, and it would have the right to come after you for those payments in the future.

If the home does go into foreclosure and is sold, the lender gets to use the money from that sale to reimburse itself for any amounts it is owed. If there are not enough funds to pay off the lender, it has the right in most states to sue a borrower for the deficiency and to collect whatever it can get, even after the home is sold.

If you stop paying your lender, if you live in a state that allows deficiency judgments, the lender can pursue you for years to come. Worse, the lender can sell the debt you owe to a collection agency, which can pursue you for years -- unless you file for bankruptcy and get the debt dismissed.

Finally, please understand that when you stop making mortgage payments, your credit history will be severely damaged. Going into foreclosure is even worse for your credit. Your credit score might take a hit of anywhere from 150 to 250 points, leaving you with a credit score in the low 500s after the foreclosure sale.

A deed-in-lieu of foreclosure is a little better for your credit history, but not much.

Q. I have applied for a deed-in-lieu of foreclosure on a vacation beach home I own, on which I can no longer make the payments. I'm 72 years old and semiretired, with a mortgage on my primary home. If the bank doesn't grant the foreclosure and I discontinue payments, will it just issue a standard foreclosure?

A. A deed-in-lieu of foreclosure is a process that a bank and a borrower take that speeds up the foreclosure process.

Instead of the bank going to court, obtaining a judgment against you, and then selling the home through a sheriff's sale authorized by the court, you and the bank agree to transfer ownership of the home to the bank.

The process is relatively simple and avoids the costs and expenses involved in the court foreclosure process. A deed-in-lieu of foreclosure is a voluntary process, and the lender is under no obligation to go that route. The bank can decide to proceed through normal channels to get money to satisfy the debt you owe.

If the bank is unwilling to work with you in a deed-in-lieu arrangement and you fail to sell the home through a short sale, and then you stop paying your mortgage, the lender can and will proceed to foreclose the home through the court system.

The bank can (and probably will) go after you personally for any shortage in the amount that it gets from the foreclosure sale. That shortage is called a deficiency, and the judgment a bank gets to collect the shortage is called a deficiency judgment.

In most states, lenders can get a deficiency judgment against a homeowner for an investment property or second home. Some states limit deficiency judgments on primary residences, but since the property in question here is a vacation home, you should expect your lender not to let you off the hook for the amount you may still owe on the loan.

There is also a tax implication: Through 2013, the IRS will not consider deficiencies on primary residences as taxable personal income. But for a vacation home, rental property or a second home, a deficiency would be treated as personal income and you will owe federal and possibly state taxes on it as well.

During the process of negotiating your deed-in-lieu of foreclosure, you should work with your lender to determine if it would be willing to waive any deficiency judgment against you. That is to say, the lender would take the property and agree that they won't go after you for anything else later.

Beware: your lender may remain quiet on the issue of whether its collection department will go after you for any amount you owe arising from your loan. And you should also know that your lender may decide to sell off the deficiency to a collection agency, and you may find yourself facing calls from a collection agency for years to come.

Chicago-based real estate attorney Samuel J. Tamkin contributed to this column. thinkglink.com; Twitter @glink
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