Mortgage Forgiveness

5/20/2020

During the mortgage meltdown that caused the Great Recession a decade ago, some homeowners lost their homes to foreclosure or constructed a short sale to get out from under the debt.  In most of the cases, the lenders forgave all or part of the debt owed them.

Similarly, in the early 90’s after the failure of the Savings & Loans in the U.S., thousands of homeowners lost their homes in the same way but back then, the policy of the IRS was to consider the forgiven debt as income.  Today, it is still considered income which means that a homeowner could lose their home because they could not afford to pay for it and to make matters worse, they would owe income tax on the debt relieved.

The good news is that in 2007, Congress passed the Mortgage Forgiveness Act and it has continued to be extended with its current expiration of 12/31/20.

The amount forgiven for income tax purposes may not be the same amount owed to the lender.  Mortgage forgiveness has a limited exclusion for discharged home mortgage debt for a principal residence only; it does not include second homes or investment properties.  Only the amount of mortgage debt that can be treated as acquisition indebtedness in included.

In the example below, a homeowner purchased a home and refinanced the home five years later at 80% of the market value.  The new loan proceeds were used to payoff the original mortgage and make $30,000 of new capital improvements.  The revised acquisition debt is the acquisition debt at the time of refinance plus the capital improvements made with the loan proceeds.

The new $400,000 loan produced $39,417 of home equity debt which is not considered acquisition debt.  Home equity debt is money borrowed on a home and can be used for any purpose, but it may not be tax deductible or considered acquisition debt.  Acquisition debt is money borrowed to buy, build or improve a principal residence subject to a $750,000 limit.

Assume that the borrower never made a payment on the new loan.   If the new loan went through foreclosure while the Mortgage Forgiveness Relief Act is in effect, the forgiveness would be limited to the acquisition debt of $360,583 and the remaining amount of $39,417 would be considered income and subject to tax.

This article is meant to inform homeowners of liabilities associated with foreclosures and possible remedies that may be available.  This example is meant to illustrate the portion of a loan that could be forgiven.  Taxpayers should always consult their tax professional regarding their specific situation and the way the law would apply to their situation. For more information, see IRS Publication 4681.

Example 
Purchase Price … 5 years ago$400,000
Mortgage at time of purchase … Acquisition Debt$360,000
Fair Market Value … Today, 5 years later$500,000
Refinanced 80% – Loan to Value$400,000
Replaced unpaid balance – current acquisition debt$330,583
Capital improvements made with loan proceeds$30,000
Revised acquisition debt$360,583
Home equity debt … difference in refinanced amount and acquisition debt$39,417

Gary Thompson
CRS, SRS, SFR, e-Pro, Broker Associate
Re/Max Masters
(801) 821-9292

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It’s Different This Time!

Of course, it is!  We haven’t experienced a global pandemic in our lifetime.  We haven’t had an economic shutdown like this before.  Uncertainty is understandable and people tend to fear what they don’t understand. With all that said, it doesn’t mean there are not opportunities for people who can act in this unprecedented environment.

During the recent Great Recession, housing prices experienced dramatic reductions in value due to the subprime mortgage crisis.  Homeownership in the U.S. peaked in 2004 at 69.2% when lenders with questionable practices would approve almost anyone who applied for a mortgage. 

Since the Great Recession, Congress and the mortgage industry enacted significant rules that require a person to actually qualify based on the ability to pay back the loan, cash and savings necessary to close, the house securing the loan and sufficient credit history.

Both first-time buyers and investors were able to capitalize on opportunities during that recession by acquiring properties at below market prices.  These buyers had good credit, the necessary down payment, income and the willingness to act at the moment.  Interestingly, those prices did not stay depressed for long.

Today, there is a big part of America that has good credit, the necessary down payment and sufficient income to qualify but are in a wait and see posture.  It is understandable that both sellers and buyers across the country are uncertain whether now is a good time for them individually to make a move. 

Consumers should understand the difference in the ability to qualify for a home and the ability to afford and maintain it.  If a buyer is secure with their income and job status, a real estate market with less competition can definitely be an opportunity.

Currently, the homeownership rate is estimated at 65.1% based on the U.S. Census Bureau.  This is only slightly lower than its all-time high.

“The housing sector enters this current recession underbuilt rather than overbuilt” states Robert Dietz, chief economist with the National Association of Home Builders, “that means as the economy rebounds … which it will at some stage … housing is set to help lead the way out.”  Ali Wolf, chief economist with Meyers Research, believes housing will be the hero this time “Last time housing led the recession.  This time it’s poised to bring us out.”

The majority of housing economists don’t expect prices to fall because we’re still experiencing a housing shortage.  Both existing homes on the market and new construction cannot meet the high demand from buyers, some who have been trying to buy and have lost bidding wars.

There is probably an equal number of sellers and buyers who are waiting to see what happens to the economy which will reduce the overall sales.  However, for the sellers who are in the market, their prices may stay solid based on the lack of inventory for the buyers who are staying in the market.

All real estate is local and each market, in its various price ranges have their own current characteristics.  If you would like to investigate how it might affect your decision to buy or sell, now or in the near future, we can arrange a video meeting.  We can provide you with current inventory levels in your area and price range, recent sales and current demand levels.