Consequences of Foreclosure
Whether you're struggling financially or unable to pay your mortgage due to unavoidable or unforeseen circumstances, it's important to understand that foreclosure is not the best move. Foreclosure comes with some far-reaching consequences that may affect your life now, and in the future.
Loss of Your Home
The most obvious consequence of foreclosure is the possibility of being without a place to call home for you and your loved ones. This can be devastating if you are unable to rely on friends and relatives for shelter. While you may be able to find an apartment to rent, if you get your finances in order, some people, unfortunately, end up homeless after foreclosure.
Emotional Stress and Uncertainty
In addition to the uncertainty that comes with not knowing exactly when you'll be forced to leave your home, going through foreclosure is very emotional and stressful.
While a foreclosure doesn't mean that you're irresponsible or a failure, it could leave you in a situation where you feel that you must defend yourself or convince others of this. In some cases,you may feel socially stigmatized as some of your friends or close relatives may distance themselves at a time when you need them most.This can be very hurtful and very stressful to deal with.
The emotional toll associated with foreclosure may be compounded by how it affects your private life. For some, having to move to another home or possibly another state can take a toll on your mental health. And for those with children, the relocation and change of school districts, can be devastating on the child and possibly affect their behavior and grades for a period of time.
According to recent studies, foreclosures have had significant psychological effects on both individuals and families. Besides being embarrassing, stressful, exhausting, and intimidating, reports indicate that foreclosures can also affect a person’s self-esteem and self-worth, often leading to depression. Therefore, we recommend that you seek appropriate help to protect your mental health if you find yourself in this situation.
Credit rating will be destroyed
Having a foreclosure on your credit report will have a detrimental effect. A foreclosure remains on your credit report for seven years. During this time, your credit score may take a hit of 85 to 160 points, which is significant, and may result in a fair to poor credit rating. This rating will affect your ability to get credit, or be forced to take credit at a substantially higher interest rate, during the seven-year period that the foreclosure remains on your report. And for existing creditors, you may be at risk of them increasing the interest rates on your current credit accounts, if their terms and conditions permits.
While we all seem to know the credit score consequences of foreclosure, most of us aren't aware that there are tax consequences that a foreclosure can bring. According to IRS Publication 4681 (2022), if you owe a debt to someone else, and they cancel or forgive that debt for less than its full amount, you are treated, for income tax purposes, as having income and may have to pay tax on this income. Publication 4681 generally refers to debt that is canceled, forgiven, or discharged for less than the full amount of the debt, as “canceled debt.”
A mortgage is an agreement between the homeowner and the lender, whereas the lender lends money to the homeowner with the promise to be paid back. The amount that is borrowed is considered a debt, until it is paid back.Once the homeowner pays the debt off, the debt is cancelled as “paid in full”.However, if the homeowner forecloses, the remaining balance owed is still considered debt, and for IRS’s purposes, it's considered“canceled debt” and is now taxable as income under IRS’s rules.
For example, If you owe $400,000 on your house and it sells for $300,000 in foreclosure, the lender can either choose to sue you for the remaining $100,000 or forgive the debt. If the latter is the case, the lender notifies the IRS of this deficiency and then the IRS looks to you to report the debt that was “forgiven by the lender”on Form 1099-C, Cancellation of Debt, and include this as part of your gross income for the year. You may then be responsible for paying the applicable income tax, plus capital gains on the debt that was canceled by the lender.This can have an impact on your finances for years if you’re unable to pay your tax liability.We recommend that you contact a tax professional for advice if you find yourself in this situation.
Problems finding a new home
You'll, of course, have to find a new place to live if you’re evicted from your home as a result of a foreclosure. Sadly, finding a new place can become extremely difficult with a lower credit score. Most landlords use credit scores to assess their tenants and may become wary of someone with a previous eviction or foreclosure on their credit report. In some cases, landlords who are willing to accommodate you, may require you to pay an inflated security deposit.
Negative Financial Spirals
The impact that a foreclosure has on your credit report is substantial and can leave you in a negative financial spiral that can be extremely difficult to get out of. Financial situations tend to become worse if there's a deficiency after the foreclosure sale as the lender will most likely sue you for the balance or report the forgiven debt to the IRS as taxable income. Anyone who has ever had to deal with the IRS knows that they are the World’s most aggressive tax collector, garnishing pay checks, seizing bank accounts and attaching liens to anything of value. This domino effect of having a foreclosure can last for seven to ten years, leaving your finances in a shambles.
Finances are the first to be affected, however, finding a good job may be difficult as well. There are some employers who pull credit reports as part of the hiring process. If a foreclosure shows up on the credit report, they may deem this as a sign that you are irresponsible and their hiring policy may prevent hiring persons with negative credit ratings. In some cases, employers have been known to fire employees who were foreclosed on, as their policy required that employees maintain a good credit standing.
Challenge of Buying a New Home
Buying a new home after going through the foreclosure process can be a real challenge. Most lenders will require a credit score of not less than 620, as well as a waiting period after the foreclosure before your loan application is even considered. In most cases, you'll have to wait between 5 and 7 years for your loan application to be considered after foreclosure for conventional financing, and after three years before the Federal Housing Administration (FHA) may consider offering you a new loan.
Negative impact on Community
Property values generally go down in an area where there are lots of foreclosed properties and this can have negative financial and social impact on the community.