California foreclosure second mortgage - can they come after you later?
Someone I will call Marsha emailed me a few days ago. She asked me:
- Richard, we got foreclosed on here in California. The second mortgage holder is now contacting us and telling us that we need to pay them for the second mortgage. I thought this was over. What gives? Do we have to pay on the second mortgage even after the foreclosure? I thought we had all this behind us, please help.
- And, we got a 1099c from the lender. Our accountant is advising us we may owe state income taxes here in California. What do you think we should do? HOw should we report the 1099c to California?
So Marsha, Richard here. I was away on family vacation out of the country and just got back yesterday, Friday, and the NY Times published a lengthy article including my website in it and the fan's been hit here. For information on the state you live in see states that are non-recourse but remember that it doesn't apply necessarily for a second mortgage.
Anyway, that's why I've been late in answering. Okay.
Yes, the junior loan can come after you. They can go to court under a breach of contract claim just like a credit card company can. It's an unsecured debt at this point, but since you signed the note, it is fair game. You have the usual defenses to it but usually those aren't much so they can force the issue eventually by filing for a summary judgment motion, getting a judgment and then garnishing wages, levying on bank accounts, or whatever.
On the other hand, perhaps they will simply go away. You never know. This second mortgage situation is a huge deal. California is a "non recourse" state but that only applies to the first mortgage in most cases. As many people are finding out, just about everywhere under current conditions, borrowers can be held personally liable for second mortgages after foreclosure has happened on the first mortgage.
Now, as to the taxes matter. As I have written before, cancellation of debt income exists whenever a debt is reduced, written down or cancelled.
Whether you owe income tax on that income is another matter.
You do not owe income tax on a federal level if you meet one of three tests:
- This was your principal residence (up to $2 million of cancellation of debt income)
- You are technically insolvent at the time of the income (meaning your debts exceed your assets, which is normally the case when we end up in these situations, since all our mortgages are counted as debts in this calculation.)
- This is a non-recourse loan.
Okay, so that is federal taxes. But what of California taxes?
I really have no idea. However, not filing the 1099c may not be a good idea. There is a simple financial statement you can fill out showing your financial position at the time the debt was canceled and if it shows a negative net worth (technically you are insolvent) you meed the federal test #2 above and wouldn't owe taxes to the feds.
California usually follows federal laws in tax matters but not always. I can't give you advice because I am not a tax preparer and not qualified but if it were me, I would probably ask my accountant for my range of options and then follow the more aggressive option. But that's just me!
See Can a second mortgage holder sue you after foreclosure? for more.
And please watch my video on how to avoid foreclosure by doing a short sale even if you have a second mortgage foreclosure situation. The answers are here. I will never share your name or email with anyone.
And watch this video on short sales and foreclosures. This is a screen shot — just type in your email and I'll get you to the real video. Thank you.