Rising Rates Swamp Homeowners; Banks Respond
After loosening their standards for loans over the last several years, banks are seeing deliquency rates rise as adjustable rate mortgages (ARMs) snap like bear traps on unwary borrowers. Today, the Wall Street Journal reports (subscription required) on the response of mortgage lenders to the 5-year high in late mortgage payments. The merits of these responses differ greatly.
A Good Response:
* Allowing borrowers with ARMs to refinance into different loans at no charge
A Problematic Response:
*Short sales, which occur when a borrower owes more on the home than it is worth. The house is sold, the bank gets the proceeds and discharges the remainder of the debt. While this can be a better alternative for borrowers than a foreclosure, it can create a potential tax nightmare. The portion of the loan that is forgiven may be treated by the IRS as income to the borrower, creating a potentially huge tax liability for an already cash-strapped individual.
Short sales help banks by allowing them to avoid the time and expense of foreclosure. Let's hope the banks are making borrowers aware of the tax implications of these transaction.
Another problem is that deficiency judgments are dischargeable in bankruptcy as an unsecured debt. If I am reading the most recent bankruptcy law changes correctly, the income taxes owed on debt forgiveness is not.
Ms. Warren, am I missing anything?
Satellite Sky Blog
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January 25, 2007 5:27 PM | Reply | Permalink
I believe that's correct. Not such a fresh start when the IRS is breathing down your neck as soon as the automatic stay is lifted.
Although it won't help most individuals, there is the possibility under s. 108 of reducing the taxpayer's basis in other depreciable real property. This defers the tax liability until the other property is sold, at which time the deferred amount is taxed as ordinary income. I don't imagine this will help the average consumer though.
January 26, 2007 5:06 AM | Reply | Permalink