We seem to be getting, not surprisingly, a lot of questions about foreclosures. A common query asked by clients recently is the question of whether a homeowner would still be liable on a Second loan after the primary lender has already foreclosed the home.
Whether you take a first or a second mortgage on your home, you are responsible for the repayment of those loans. The general rule is that a home is merely used as a security against your loan. The fact that the home was foreclosed and there was only enough money to pay the first loan merely cancels the security of the second loan but you will still remain liable on the second mortgage loan.
The important thing to understand is that the homeowner is liable for a loan. The property is only used as a collateral for that loan. When a first loan forecloses the property, it may wipe out the security interest of the second loan but it does not wipe out the second loan itself. Hence, the second lender can still run after the homeowner in a collection action.
Fortunately for some homeowners who live in California (and some other states), there may be exceptions where the second loan itself can be extinguished. This would be limited to cases where the second loan was for a “purchase money” loan (a loan that is used to buy a house as opposed to a refinance or a home equity line). These loans refer to cases where the homeowner had incurred both the first and the second loan at the same time during the initial purchase of a home. The theory is that both the first and second lender made the purchase of the home possible and should not have done so if they weren’t willing to accept the house as their only collateral.
The follow-up question that many clients often ask in conjunction with foreclosure is the question of taxation. Lenders usually issue IRS form 1099-C on the cancelled debts of these foreclosed properties. Homeowner Juan, for example, may have a first mortgage loan of $400,000 and a second mortgage loan of $100,000. When homeowner Juan’s home was foreclosed, it was sold at auction for only $350,000, which was not able to satisfy both the first and second loan. Juan received an IRS form 1099-C from the first lender in the amount of $50,000 for the unpaid debt; and, another 1099-C from the second lender for remaining $100,000 unpaid debt also. Is Juan liable for taxes on the $150,000 ($100,000 + $50,000) cancelled debts?
Under the Mortgage Relief Debt Relief Act of 2007 the US Congress allowed taxpayers to exclude income from the discharge of debts in their principal residence. Hence, debt relief forgiven in connection with a foreclosure is not taxable. This law applies to foreclosures and debt relief for the calendar years 2007 to 2012. It is also important to note that this law applies to a “primary” residence only and different rules apply to second homes or investment properties.
A little caveat for our readers is that there are 50 different states, so there would probably be 50 different answers to this question. Practicing in California, I have discussed this question based on California law. Though the law in California may be the same in many other states, it is suggested that readers seek proper legal advice for their individual situations. The discussions above may or may not be applicable to all situations.
(DISCLAIMER: material presented above is intended for informational purposes only. It is not intended as professional advice and should not be construed as such. Rey Tancinco is a partner at Tancinco Law Offices, a professional corporation with offices in San Francisco, Vallejo, and Manila. The law office website is at: tancinco.weareph.com/old. Rey Tancinco can be contacted at (800) 999-9096 or (415) 397-0808 or via email at: attyrey@tancinco.com.)
