Zombie Mortgage Debt Isn't Just for Halloween

If you think there are a lot of zombies in The Walking Dead, you should see the nation's financial sector -- it's crawling with them!

These financial zombies are a whole lot harder to kill off than the ones you see on a television or cinema screen. And once you're perceived as a likely victim, these can haunt you for many years.

Dead Slow

Your mortgage debt "dies" when you pull off a short sale or the lender forecloses, right? Wrong! Depending on the property location, you may still owe any shortfall if the foreclosure sale proceeds don't cover the amounts owed. That shortfall is called a "deficiency" and courts in 40 states plus D.C. can issue deficiency judgments ordering you to pay the difference -- plus attorneys' and court fees and years' worth of interest. Many face zombie foreclosure debt running into six figures.

Some mortgage lenders are clever about this. If they know they have little chance of getting anything from ex-homeowners immediately after a foreclosure, the bide their time, waiting until debtors recover financially, and only then hit them with a deficiency judgment -- sometimes years after borrowers believed they were free and clear.

In June 2013, The Washington Post related the story of Jose Santos Benavides, 46, who bought a Rockville, Md. home in 2007 for $469,000. The recession hit him hard, and in Aug. 2008 the property went into foreclosure. Three years later, his lender came after him for a deficiency of $115,000.

Night of the Living Debt

Even if you're lucky enough to live in a state that prohibits deficiency judgments on first mortgages, you might still be liable for the full outstanding balance of any second mortgage(s) or home equity lines of credit (HELOCs) that weren't paid off by the foreclosure sale. Lenders may even apply to a court to garnish your wages.

If you're facing foreclosure, and have a second mortgage or HELOC that won't be cleared by the sale, you still have time to negotiate with your lender. Its expectations of seeing any money at all may at this point be low, and you could even find yourself settling for cents on the dollar. Your position may weaker if your foreclosure has already happened, but you still might head off the garnishing of your wages if you negotiate a sensible settlement or payment plan.

Dawn of the Debt

In 2009, Rose Nathan of South Bend, Indiana left her home, two weeks after a Christmas Eve call from her bank (Why don't more people recognize the sensitivity of those employed in the financial sector?) telling her she had to get out because the sheriff would soon turn up to evict her. She sold everything and moved to Hawaii.

Nathan had arranged a deed-in-lieu of foreclosure with her mortgage lender, so she knew she wasn't liable for any shortfall between what she owed and the proceeds of the sale of her former home. She was wrong -- nearly two years later, she received a demand for close to $5,000 in property taxes from the City of South Bend.

Her bank may have told her it was foreclosing, but in reality it postponed transferring the deed. That meant Nathan technically remained the home's legal owner, and therefore retained responsibility for property taxes. Who knows whether that was a sharp, money-saving tactic on the part of the bank, or an administrative hiccup? But CNN speculates that there may be tens of thousands of similar cases, which it terms "zombie foreclosures".

Tax Collectors: The Ultimate Flesh Eaters

Until recently, if a foreclosing mortgage lender forgave part of your debt, the IRS treated the amount forgiven as income for taxation purposes. Yikes! The Mortgage Debt Relief Act of 2007 changed all that, and most cancelled debt on first mortgages was granted federal tax relief for the calendar years 2007 through 2012. Congress subsequently extended that period to include 2013. The IRS's Web site explains how the act's provisions might apply to you.

If you default on a cash-out refinancing, second mortgage or HELOC (not for home improvements), you might owe federal income tax on the benefits you received from cancelling these debts. It's also possible that your state's taxation office may be looking for its share of any sort of debt relief you've received, even if the Mortgage Debt Relief Act means the IRS isn't. If you think you may be liable, it would probably be worth your consulting a tax professional or trawling through the relevant tax authorities' web sites.

Avoiding Nightmares

If you're worried about either a deficiency judgment or court action over a foreclosure or short sale, check out the general advice offered on NOLO, a legal website. If you are still concerned, consult an attorney or a credit counseling agency approved by the U.S, Department of Justice. You may be able to discharge your zombie deficiency with a bankruptcy filing, or make it go away with a letter from a smart lawyer.

Halloween is just one day a year. Taking action against zombie debt can keep it that way.

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