Once a home is lost to foreclosure, the homeowner’s credit score will drop by as much as 250-280 points. Only three years or more of on-time payments will restore the credit score. In case the foreclosure is an isolated event and the credit record is otherwise sound, consumers may be able to rehabilitate their records in 24 months. But this is a rarity as foreclosure normally comes hand in hand with escalating rates that only push the individual deeper and deeper into debt.
Many years of expensive and limited credit are the long term consequences of foreclosure, making financial recovery very difficult, if not near to impossible. The components of a FICO score consist of payment history, amounts owed, length of credit history, new credit, and types of credit used. To qualify for a conventional loan, most borrowers will want to see a credit score above 620. With foreclosure dropping scores by 250-280 points, this becomes increasingly difficult. See the figure below.
While it’s common to hear about money issues and foreclosure, few realize the tax consequences of such a process. A foreclosure brings about a property title transfer and subsequent tax assessment. Most property owners do not realize that by losing their home to foreclosure, there are likely going to be tax implications.
Basically, any time debt is forgiven; it is considered a taxable event. The IRS states that any borrowed money that is not paid back is considered as income and is taxable. A mortgage involves the bank or lender granting funds to the owner in return for a promise to pay the funds back. When the owner begins repaying the money, this money is not claimed as income on their tax return. If, however, this debt amount is canceled or forgiven, it will have to be included as income for tax purposes. The loan amount is considered as income because there is no longer an obligation to repay the lender for the same.
Once the property is finally sold, the tax consequences come in. The original loan was based on the value of the property, but these values keep changing. If the property is sold for less than it was originally worth, and the bank is unable to recover all the money it had lent, the balance is reported to the property owner and the IRS on a Form 1099-C, Cancellation of Debt. This amount is considered as income and must be reported on the homeowner’s income tax form leading to capital gains and income tax applicable.
Typically, the only instance where such income is not taxable is when debts are discharged through bankruptcy. Canceled debt tax may apply if the homeowner is labeled insolvent or with reference to certain farm debts and non-recourse loans. It’s always the wisest and safest course of action to consult a tax professional to advise on your specific situatoin and what you can expect.
It is common, following a foreclosure, for the borrower to seek a future mortgage. While it might take some time and might be a bit more difficult, it is certainly not impossible to purchase a home following a foreclosure. Most lendors will require a waiting period before they would consider a loan application.
If foreclosed owners who can explain the extenuating circumstances — generally situations beyond one’s control, they may experience shorter waiting period. Situations that may be a factor could include death, illness, job transfer or accident resulting in severe injury. If there are documented extenuating circumstances, they could have a direct bearing on the number of years to wait to get a conventional loan.
One of the best options for obtaining a mortgage after foreclosure is with a federally insured FHA loan. Three years is the minimum time required between the completions of foreclosure until approval of an FHA loan, regardless of any extenuating circumstances. FHA borrowers still have to prove good bill-paying habits since the foreclosure for any approval as well.
In the event that foreclosure leads to relocation, there are times when a new job hunt is necessary. Unless the job being applied for deals with the direct handling of money, there is no need for foreclosure to be referred to in a job interview. The federal Fair Credit Reporting Act has rules that all employers must follow.
These include notifying a job applicant before conducting a credit check. Most companies limit checks as a result. The only instance where this does not apply is if a foreclosed owner is applying for a financial job. In such situations, the individual should have a ready explanation about the reasons behind the foreclosure and how the process has changed his or her personal money-management skills as a result. This is often enough to alleviate any potential employer issues.
A common misconception that occurs is that the bank automatically ‘wins’ when a foreclosure happens. While the bank does sometimes get back the money that is owed, in most cases, the bank loses precious time, money, and resources in dealing with a foreclosure. A foreclosure is an expensive process after adding up the legal fees, resource expenditures, home maintenance, and real estate taxes. During the foreclosure process, the bank is responsible for the upkeep of the house and any real estate fees. Certainly, foreclosure has ramifications that extend to homeowners as well as the lenderss.
It’s easy to see that the effects of foreclosure are not limited to the lives of the homeowner and his or her family alone. For those facing foreclosure, it is important to review all the facts before the event with both the lender and a good tax planner. Pre-preparation and knowledge of the tax laws will make a world of a difference when it comes to minimizing the consequences of a foreclosure.
At CESI, we understand that a foreclosure can be a devastating experience. Apart from legal proceedings and financial difficulties, your home and living situation is impacted. If you are concerned about debt and fear that foreclosure could result, there is help available. Check with a Housing Counseling Agency in your area to see if they have programs and assistance that can keep you from losing your home.
If you would like to speak to a certified credit counselor for a free financial assessment, we’d love to help. Taking action before an event like foreclosure might just be enough to turn things around and get you on the right track. Contact us today!
We believe that education is the key to a better financial future
Consumer Education Services, Inc. (CESI) is a non-profit service provider of comprehensive personal financial education and solutions for all life stages and for all of life’s milestones. Our goal is enhanced economic security for everyone we serve.
CESI is NOT A LOAN COMPANY