Lenders may not collect deficiencies—at least in Tennessee

If you have lost your home in foreclosure, can your lender require you to pay the deficiency-the balance of the mortgage that remains after your home was sold in the foreclosure sale? Across the nation, about 40 states allow lenders to sue homeowners for the deficiency remaining after the foreclosure sale. However, a Tennessee bankruptcy court ruling recently changed that, at least for homeowners in Tennessee.

Typically when homeowners lose their houses in foreclosure, their lender will send them IRS Form 1099-C, which is used to calculate any state or federal taxes owed on the forgiven debt-the deficiency in other words. A Tennessee bankruptcy court recently held that although the form itself does not cancel the debt (or deficiency) that the homeowner owes on his or her mortgage, the form is evidence that the lender discharged the deficiency, meaning that it does not intend to collect the debt.

As the forgiveness of the deficiency is considered income for tax purposes, the court held that it would be unfair for homeowners to be liable twice for the debt-once for taxes and once to the lender for the deficiency itself.

Although the court's decision reflects the minority view, the court asserted that it was the proper view in the interests of justice and fairness. As a result of this decision, Tennessee homeowners who have been foreclosed upon need not fear being sued for the remaining amount of their mortgages.

Consider bankruptcy before foreclosure

Although this decision offers some relief to homeowners after they have experienced foreclosure, it is cold comfort for those struggling with their mortgages. If you are in this situation, it is better to stop foreclosure before it begins. One of the best way to do this is through Chapter 13 bankruptcy.

Chapter 13 bankruptcy works by consolidated all of your debts into a payment plan to be repaid over a three to five year period. During Chapter 13, foreclosure and repossessions are halted as your secured debts (e.g. mortgage or car loan) are brought up to date over the repayment period.

Although any arrearages you have on your secured debt are taken care of, the same cannot be said for your unsecured debt (e.g. credit cards and medical bills). Under the bankruptcy laws, such debts are paid last, if at all. In most cases, you do not have to pay most, if any, of your unsecured debt. Once the bankruptcy repayment period has been completed, the court discharges the remainder of your unsecured debt. This means that you emerge from bankruptcy free of your unsecured debt and current on your secured debt, giving you a fresh financial start.

In addition to first mortgages, Chapter 13 can help with second or third mortgages. If the value of your home is worth less than your outstanding mortgages, Chapter 13 can eliminate your obligation to pay your second and third mortgages entirely.

If you are struggling with your mortgage payments, don't wait until the situation gets worse. An experienced bankruptcy attorney can inform you of your debt relief options and recommend one that would be right for your financial situation.