Foreclosure

• A foreclosure is a legal proceeding in which your mortgage company takes back the house if you default on your payments. Foreclosure laws and procedures vary from state to state, but generally, foreclosed homes are sold at public auction after a notice period. The mortgage company uses the sale proceeds to pay outstanding property taxes and its own outstanding balance. Some states provide a statutory right of redemption, which means the homeowner has a certain period of time to try to repay the mortgage company in full. Some states, however, do not provide such a right, and the foreclosure almost immediately terminates your ownership if you live in such a state.
  
  

Deficiency Balance

• If the home sells for less than the balance due, the difference between the balance due and the sale price is called a deficiency balance. If the mortgage company forgives the deficiency balance and does not require you to pay it, the IRS may tax you on the forgiven debt. If the mortgage company does not forgive the deficiency balance, you will be liable to repay it to the mortgage company. For example, if you owe $125,000 on your mortgage and the home sells for $100,000 at foreclosure, the deficiency is $25,000. You will either have to pay taxes on $25,000 if the mortgage company forgives the debt or you will owe the mortgage company $25,000.
  
  

Surrender in Bankruptcy

• If you do not wish to keep your home or you cannot afford to keep it, you can surrender the property in bankruptcy either before or after the foreclosure. The deficiency balance will be discharged in the bankruptcy, so you will not owe it to the mortgage company, and you will have no tax consequences, because debts discharged in bankruptcy are not taxable income.
  
  

Cure in Chapter 13

• If you want to use bankruptcy to keep your home, you must file a Chapter 13 case, which is a repayment arrangement and which will help you cure the arrears on your mortgage. You must file the Chapter 13 before the foreclosure sale occurs. Bankruptcy automatically stops foreclosure. Once the foreclosure is stopped, the mortgage company cannot go forward without court permission. However, if you wait to file until after the foreclosure sale, a Chapter 13 case cannot help you. Your home will be lost unless your state has a redemption statute and you are able to redeem the property.