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1099 After Foreclosure | Cancellation of Debt Income

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As we noted in Foreclosure Law, foreclosure is the process by which a bank or lender takes possession of collateral used to secure a loan. Put another way, foreclosure happens to a homeowner when he or she doesn’t pay their mortgage. And in What Is a Deficiency Judgement in a Foreclosure | Debt After Foreclosure we discussed that cancellation of debt is a likely outcome following a foreclosure.

1099 After Foreclosure |

Foreclosure devastates credit–the only greater “derogatory” on a credit report is a bankruptcy. If you follow your FICO scores, you would tend to see a drop in the 120 to 150 point range. The amount of the drop will vary depending on the other items on your credit report. A person with good credit might fare quite well, while a person with average or low credit will likely find himself in the high 400s or low 500s–the “radioactive” zone.

However, a credit score is an estimate of one’s creditworthiness today, and so as derogatories (a major blemish on a credit report is called a derogatory in credit parlance) pass into the past, the effect of derogatories lessens. Your score will tend to rise over time.

So, before a foreclosure happens to you, you should do some pre-foreclosure credit planning–you may likely not have borrowing power in the two year period following your foreclosure. So, if you absolutely must borrow to buy a car in the next year or two, you’ll get a better rate before the foreclosure goes on your credit report. In fact, after a foreclosure, you might not be able to borrow for a car loan at all. Of course, good fiscal health dictates that one should never borrow to buy a car–but that’s another topic.

How To Improve Credit After Foreclosure

Foreclosure is a big hit to a credit report–don’t compound it by creating other derogatories. Keep everything else clean on your credit report. That means paying bills on time, and avoiding requests for new credit. A request for new credit creates an “inquiry” on your report, which lowers your score by a small amount. Make a slew of inquiries, and you might lower your score by 20 points or so.

Credit reporting agencies are allowed by law to report your payment history on a credit report.

Foreclosure devastates credit–the only greater “derogatory” on a credit report is a bankruptcy. If you follow your FICO scores, you would tend to see a drop in the 120 to 150 point range.

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Legal Form | Credit Repair: Method of Verification Demand

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-This is a sample “MOV” or “method of verification” letter. It’s an advanced tool in a consumer’s credit repair arsenal. Before using it, you should read about Method of Verification.

Experian

701 Experian Parkway

Allen, TX 75013

RE: Fair Credit Reporting Act Request under § 611(a)(0)

To Whom It May Concern:

Time is of the essence with regard to this request. You have made an error in my credit reporting that is harming my ability to secure employment and credit. I have documented your errors, and I will continue to do so. I will avail myself of my rights under the Fair Credit Reporting Act if you continue to violate my rights.

This letter is a request under the Fair Credit Reporting Act §611(a)(7) following a request for investigation that I made under the section just previous in the FCRA, specifically §611(a)(6). I have received the results of my 611(a)(6) request, thank you for that. Please do not interpret this letter as a request for further investigation under 611(a)(6).

As you well know, the FCRA governs your handling of my personal information. And, my request today is my statutorily-granted right to learn the method and description of the reinvestigation procedure you utilized. Section 611(a)(7) states:

(7) Description of reinvestigation procedure
A consumer reporting agency shall provide to a consumer a description referred to in paragraph (6)(B)(iii) by not later than 15 days after receiving a request from the consumer for that description.

The specific entry for which I request a description of reinvestigation procedure is the following entry:

CountryWide Account No.: 5262****

You have already ignore a previous request for a description of the investigation procedure. In my original request for investigation, I state the following:

“Be advised that the description of the procedure used to determine the accuracy and completeness of the information is hereby requested as well, to be provided within 15 days of the completion of your reinvestigation.”

I received no response to my request.

I am sure that you can tell from this letter that I am familiar with my rights, and I am familiar with the Fair Credit Reporting Act. I am also familiar with my statutory right to damages if you conduct your stewardship of my personal information in a manner inconsistent with the clear dictates of the FCRA.

As such, I have already documented the errors you have made, and I will continue to do so. You must conduct your business not only in a manner that is convenient and economical for you–but also in a manner that comports with the FCRA. And, if you wish to farm out your responsibilities to CSC Credit Services, I will still expect that you meet the timelines imposed by the FCRA.

I look forward to receiving the description of the investigation procedure.

Yours truly,

Larry David

For the purposes of verification only, and not for correction, my personal information appears below: Larry David, 12/20/1984, 040-55-5555Current address: xxxxxxxxxxxxPrevious address: xxxxxxxxxxxx
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Method of Verification – Credit Repair Device

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At least one major credit repair website touts “Method of Verification” as a “secret credit repair tool.” Well, not exactly. Method of Verification, or “MOV,” refers to a statutory right that consumers enjoy to demand that a credit reporting agency (transunion, equifax, etc.) supply upon request the method of verification when a consumer asks that an entry on their credit report be reinvestigated. MOV is powerful, though, but as we’ll see, you’ll need to push pretty hard to get the CRAs to honor your request.

To truly understand MOV, lets take a step back. A consumer enjoys the right to demand that a credit reporting agency reinvestigate incorrect information that appears on the consumer’s credit report. We discussed this and supplied a tried-and-true sample letter for credit repair. This right, as well as a demand made pursuant to the right, is abreviated as a demand to “confirm or delete.”

CRAs, being corporations that must turn a profit, hardly raise a finger when a demand for confirmation or delation is made–the CRAs don’t really investigate, they use a computerized system called eOscar that “verifies” the credit report entry without true human intervention. Essentially, the CRAs do just enough not to be sued for failing to follow the statute.

Following a confirmation by a CRA, the consumer does enjoy a little-known right: the right to request the method of verification undertaken by the CRA. The right is found in the Fair Credit Reporting Act (FCRA) Section 611. It states “A consumer reporting agency shall provide to a consumer a description referred to in paragraph 6Biii [the section requiring reinvestigation] by not later than 15 days after receiving a request from the consumer for that description.”

Is it magic? Well, it would be if the CRAs made a common practice of complying with the law. Most times the CRAs simply deny that they have a responsibility to provide the method of verification. The statute is plenty clear, though, and it’s always a good idea to make the request. Certainly, you’d need to make the MOV request before suing for non-compliance with the FCRA.

For a sample form, visit our Sample Method of Verification Letter.

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Foreclosure Law | Foreclosure Help | Stop Foreclosure

What Is Foreclosure? 

Foreclosure is the process by which a bank or lender takes possession of collateral used to secure a loan. Put another way, foreclosure happens to a homeowner when he or she doesn’t pay their mortgage.

Foreclosure is not always a court action. There are two types of foreclosure: judicial foreclosure and trustee’s sale (non-judicial) foreclosure. Some states use one or the other, and some states (like California), use both. Judicial foreclosure is just like it sounds: it is a lawsuit by a bank against a lender to secure a judgment of foreclosure. This means paperwork, court proceedings, motions, orders, appraisals, and a formal auction. As such, judicial foreclosure is more expensive for a bank, and takes longer.

A trustee’s sale is a walk in the park for a bank: The trustee names in the deed of trust (mortgage) simply needs to record a public notice of default to initiate a non-judicial foreclosure against the owner. No court intervention is required. If the owner doesn’t pay in a certain amount of time, the trustee can schedule a public sale of the property.

Homestead Protection

If you are sued for a debt that is not related to your home, you may enjoy homestead protection–a large amount of the equity in your home may not be reachable by outside creditors–but homestead protection does not protect you from the amount that you owe to lenders who have mortgages against your property. We discuss homestead protection in this article: Homestead Exemption.

Deficiency Judgments

Deficiency Judgments are legal judgments available (in only some states) to banks and lenders if the foreclosed property does not yield enough money at a foreclosure sale to satisfy the entire mortgage loan. That’s a mouthful, so the following explanation should make it clearer. Say you buy a property with $20,000 down, and you borrow $80,000 from First Bank. You fall behind, and First Bank forecloses on the property and the property yields $70,000 at a foreclosure sale. Well, the bank is still out $10,000. That “deficiency” may be the subject of a deficiency judgment if the bank wants to pursue it. That said, banks don’t always have the right to pursue deficiency judgments, and even when they do, they don’t always seek deficiency judgments. We discuss deficiency judgments at length generally, and with respect to California read Deficiency Judgement, Anti-Deficiency Laws, California and Elsewhere.

Why Foreclosed Homeowners Receive 1099s for Cancelled Debt First, the basics: if you owe a debt to someone else, and that debt is forgiven, the IRS Code treats that forgiven debt as income to you. Does it make sense? Sure, because you have just received something that you did not have before. And so, when a homeowner loses a property in foreclosure, banks will typically charge off (forget about) the mortgage loan and simply issue to the former borrower a 1099 for the amount of the loan that the bank forgave. For example, if you bought a house with a $100,000 loan, and the bank received $80,000 in a foreclosure proceeding, that leaves $20,000 to collect from you, the borrower. Now, the bank might sue you for the $20,000, or the bank might simply forgive the debt. If the bank forgives this debt, the bank will issue you a 1099 for the amount of $20,000–what they do depends on state law (more on this below) and the circumstances of your individual case. This example is over-simplified, actually, the bank may also include in the 1099 expenses, fees, late fees, and whatever other fees originally appeared in your loan contract.

More Information on Foreclosure and Anti-Deficiency

For more information, see our full article on 1099s and cancelled debt entitled 1099 After Foreclosure – Cancellation of Debt & Anti-Deficiency.

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Deficiency Judgement, Anti-Deficiency Laws, California and Elsewhere

July, 2007

As we noted in Foreclosure Law, foreclosure is the process by which a bank or lender takes possession of collateral used to secure a loan. Put another way, foreclosure happens to a homeowner when he or she doesn’t pay their mortgage. And, in California Foreclosure Law, we looked more closely at the law and process surrounding foreclosure in California.

Anti-Deficiency Laws Protect Real Estate Debtors

An anti-deficiency law is a law that states that a lender in a real estate transaction cannot pursue a judgment against the borrower if the borrower defaults on the underlying real estate loan and the lender fails to recoup the entire amount of the loan.Section 580b Anti-Deficiency Protection for Purchase Money Mortgages for 1-to-4 Unit Properties Section 580b prohibits a deficiency judgment against a borrower who incurred a loan to purchase a residential property (as opposed to a refinance), and if that property is one-to-four units. Refinance loans do not fall within 580b–so refinancers beware, you might be giving up some anti-deficiency protection if you refinance your original purchase money loan. Nevertheless, refinancing borrowers may still enjoy anti-deficiency protection by virtue of Civil Code 580d.

An example will illustrate: Assume a borrower borrows $500,000 from a lender to purchase a property costing $550,000. Soon after, the borrower falls behind in his payments, and the bank is forced to foreclose, and the home is ultimately sold for $400,000. The $100,000 that the lender lost on the deal is called a “deficiency” or “deficiency judgment.” In California, in some circumstances, the bank can not sue the borrower for the amount of the deficiency–hence the term “anti-deficiency protection.”

California’s anti-deficiency rules are found in Section 580 of the California Civil Code. There are two separate provisions, and the two provisions overlap slightly:

Section 580d Anti-Deficiency Protection for All “Trustee’s Sale” Foreclosures

Section 580d sets forth far broader anti-deficiency protection. Section 580d protects all borrowers from anti-deficiency protection in foreclosures that are “power of sale” or “trustee’s sale” foreclosures–as opposed to a judicial foreclosure. We discussed judicial foreclosures, and we noted that judicial foreclosures are very rare, and is almost never used in residential foreclosures.

And so, with such powerful anti-judgment protection for borrowers, what happens to the loan that the lender made? In short, the lender takes a loss on the loan, and the borrower, while immune from lawsuit, gets a very serious negative mark on his or her credit.

There is another curious after-effect to a California foreclosure where lender is blocked by the anti-deficiency rules: the lender issues a 1099 to the borrower in the amount of the lender’s loss on the loan. The 1099 is issued for “cancellation of debt” income–which is, technically speaking, taxable income under the US tax laws. Credit card companies often issue 1099s for “COD” income when they write off a bad debt. The lender, by issuing a 1099, can write off the lost loan and reduce its taxable income.

A foreclosed borrower faced with a sizeable 1099 can still maneuver and avoid a stiff tax bill: the foreclosed borrower may exclude the amount of the forgiven debt from his or her income. The borrower must file IRS “Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness.” If the borrower is insolvent at the time of the forgiven debt, the IRS may forgive the liability.

If faced with such a 1099–get some professional guidance, it’ll go a long way.

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California Foreclosure Law | Foreclosure in California

As we noted in Foreclosure Law, foreclosure is the process by which a bank or lender takes possession of collateral used to secure a loan. Put another way, foreclosure happens to a homeowner when he or she doesn’t pay their mortgage.In California, there are two types of foreclosure: judicial foreclosure and trustee’s sale (non-judicial) foreclosure. Judicial foreclosure is very rare, and is almost never used in residential foreclosures. Judicial foreclosure is just like it sounds: it is a lawsuit by a bank against a lender to secure a judgment of foreclosure. This means paperwork, court proceedings, motions, orders, appraisals, and a formal auction. As such, judicial foreclosure is more expensive for a bank, and takes longer. There are other important differences to the homeowner that we’ll cover in a moment.
 
A trustee’s sale is a walk in the park for a bank: The trustee names in the deed of trust (mortgage) simply needs to record a public notice of default to initiate a non-judicial foreclosure against the owner. No court intervention is required. If the owner doesn’t pay in a certain amount of time, the trustee can schedule a public sale of the property.

Judicial Foreclosure vs. Trustee’s Sale Foreclosure (Non-Judicial Foreclosure)

But now to the important differences between judicial foreclosure and a trustee’s sale:
1. In a judicial foreclosure, the borrower is entitled to a 1-year “right of redemption” by which the borrower enjoys the right to repurchase the property from a successful bidder. This puts a real damper on the auction sale price, as one might imagine.
2. In a trustees sale, the bank cannot get a deficiency judgment against the borrower (on certain residential property). In short, that means the bank cannot sue the borrower for the difference between the bank loan and what the bank received at the trustee’s sale.

Anti-deficiency is a good deal for homeowners whose properties are “underwater,” (where the value is less than the total amount of the loans).

Foreclosure Defaults and Timelines

The short answer: a foreclosure in California takes about 7 to 9 months from when a borrower first misses a payment. When a borrower misses a payment on a mortgage loan, the bank springs into action. The bank will make telephone calls to the borrower and ask for payment. The representatives making these calls are low-paid hourly workers. They are trying to collect payment, but will also record what the borrower says into a database. At this stage, the lender is trying to establish whether the loan is in trouble or not, and try to get the borrower up to date. As a borrower falls further into default, the bank will continue collection efforts. After three or four months with no payments, the bank will send to the borrower a notice advising that foreclosure will begin in 30 days. Upon the expiration of that 30 days, the bank will file a “Notice of Default.” This notice (familiarly called an “N.O.D.”) is a key event in the foreclosure process: once the N.O.D. is filed, the wheels of foreclosure begin to turn. Keep in mind, though, that the N.O.D. won’t get filed until the borrower is 3 to 5 months behind in payments. Recently (in mid-2007), I have experienced lenders taking much longer to file N.O.D.’s–they do not appear to be in a rush.

After the N.O.D. is filed, the “redemption period” begins. The redemption period is simply a period of dormancy during which the borrower can “cure” the default by bringing his payments up to date. If the borrower does nothing, at the end of the redemption period, the “publication period” begins. The redemption period lasts 90 days from the N.O.D. filing.

The publication period lasts another 30 days beyond the redemption period. At the commencement of the publication period, the Trustee prepares a Notice of Trustee’s sale and published in a newspaper of general circulation in the city where the property sits. Up until 5 days before the trustee’s sale, the borrower enjoys a right to reinstate the loan by bringing all payments current.

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