After Foreclosure

A common question asked by homeowners whose home has been foreclosed upon is, “Can my lender sue me after foreclosure in San Diego?”  Whether or not your lender can sue you after a foreclosure of your home in San Diego, depends on the nature and circumstances of your loan.

Can My Lender Sue Me After Foreclosure in San Diego

If you only had one loan against your home and the loan was used for an owner occupied dwelling (you lived there), your lender cannot sue you, period.   California has laws that protect you from being liable for a “deficiency” balance after a foreclosure.  A deficiency balance refers to the amount of your loan balance that is still owing after your lender forecloses, sells your home, then applies the sale proceeds to your outstanding loan balance.

Owner Occupied Dwelling

If your loan was not used for an owner occupied dwelling (you purchased a rental or investment property), then your lender can file a lawsuit requesting a judgment of judicial foreclosure and a deficiency balance judgment against you.  This is in theory.  In practice, lenders rarely file lawsuits for judicial foreclosure.  Instead, lenders simply conduct a private foreclosure sale by filing a Notice of Default and then a Notice of Trustee’s Sale.  Lenders figure that the private sale remedy is much quicker and more efficient and they write off any deficiency balance as a loss on their taxes.

Also, California’s anti-deficiency laws provide that once your lender forecloses it cannot later sue you for a deficiency balance.  If your lender wanted a deficiency balance, it was required to file a lawsuit requesting a judgment of judicial foreclosure and a judgment for a deficiency balance.  Usually the only time a lender will file a lawsuit for judicial foreclosure is if the lender is a private investor or hard money lender.  The large institutional lenders rarely, if ever, file such lawsuits.

Sold-Out Junior Lienholder

If you had two loans against your property, and the 1st loan foreclosed and wiped out the 2nd loan, then your lender holding your 2nd loan may be able to sue you and obtain a Judgment against you.

When a lender holding a 2nd loan against your property is wiped out by a foreclosure by the lender holding the 1st loan, the wiped out lender holding the 2nd loan cannot sue you if the 2nd loan was used to purchase your home.  This was very common during the real estate bubble years when many homeowners bought their homes without putting any down payment.   These homeowners took out two separate loans, typically one loan for 80% of the purchase price of their home and another loan for 20% of the purchase price, the 20% loan being essentially a loan used to pay a 20% down payment.

However, your 2nd loan was taken out after the purchase of your home, typically in the form of a Home Equity Line of Credit (HELOC), then the holder of the 2nd loan can sue you after a foreclosure by the holder of your 1st loan so long as the 1st and 2nd loans are not held by the same lender.  If a single lender holds both your 1st and 2nd loans, then the holder of the 2nd loan cannot sue you after a foreclosure by the holder of the 1st loan.

Will I Owe Taxes After Foreclosure?

Regardless of whether or not your lender can sue you, after a foreclosure your lender will write off any deficiency balance and issue you a 1099C for tax for canceled debt.

The IRS will then assess income taxes against you and you will owe income tax debt based upon the amount written off by your lender on the 1099-C as if the amount written off by your lender was money that you had actually earned from employment.

Bankruptcy Eliminates Tax Liability

If you receive a form 1099-C, you can file bankruptcy and that will eliminate your tax liability resulting from a foreclosure sale.  However, bankruptcy may not be necessary to eliminate your tax liability.

Mortgage Forgiveness Debt Relief Act of 2007

If you have received a a 1099-C for canceled mortgage debt, bankruptcy is usually the only option for eliminating the tax liability. From December 2007 through January 1, 2014 there was another option, however that option ended January 1, 2014.

In December 2007, as a result of the increasingly high rate of foreclosures, the United States Congress enacted a temporary law called the Mortgage Forgiveness Debt Relief Act of 2007.  The Act created a Qualified Principal Residence Indebtedness exception to 1099C tax liability.  Under this exception, you are generally not liable for 1099-C income resulting from a foreclosure or short sale if: (1) The property is your principal residence; and (2) The loan was used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes.

The Act, which was set to expire at the end of 2012, was extended through January 1, 2014 by a provision in the American Taxpayer Relief Act of 2012.

Under the Act, if at the time of the foreclosure you were actually living in your home and your loan was used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes, then you would not owe any taxes after foreclosure. If the second loan was not used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes, then you would have tax liability to the IRS and you needed to file bankruptcy to eliminate your tax liability.

You can read about the Act in more detail by viewing the IRS Publication 4681, which is directly from the IRS and discusses the details of the rule and provides helpful examples.