Should I Let My Rental Property Go to Foreclosure?
Should you let your rental property go into foreclosure? Well, that depends on a number of factors. Foreclosure is not something that should be taken lightly. A foreclosure listing on your credit report remains there for up to seven years. This affects future credit offers, loan interest rates and sometimes even employment applications. If there are tenants currently renting the home, that creates another problem. In some cases the lender will uphold the lease, but this is not always the case. The decision to let a property go is a difficult one that requires much deliberation.
Tenant Rights
If you have tenants occupying your property, it is advisable to notify them if you are considering foreclosure. This will give them sufficient time in which to secure other housing. Not letting them know will result in the renter frantically trying to find a new home after the home is sold. Since the lender deals exclusively with the property owner, the renter typically is not aware of the pending foreclosure until the notice is issued and taped to the door. At that time, the lender usually gives the renter 90 days time frame in which to move. Some states, such as New Hampshire and New Jersey, have laws protecting tenants in case the property goes into foreclosure. These state laws allow the tenants to remain as long as they are fulfilling the terms of their lease agreement. A recent federal law grants tenants 90 days after the foreclosure sale to vacate the home.
Tax Liabilities
Because a rental property is not your primary residence, the Mortgage Forgiveness Debt Relief Act will not protect you from a tax liability if your lender forecloses. The tax liability arises when your lender reports to the IRS that your debt has effectively been canceled due to the foreclosure sale. The difference between what the lender collects at the foreclosure sale and the remaining mortgage amount is reported to the IRS. The IRS views this difference as income to you, even though you actually do not have this money. For example if the outstanding mortgage balance on your rental property is $200,000 and the bank sells the home at auction for $180,000, the difference of $20,000 is now added to your tax return as income. The Mortgage Forgiveness Debt Relief Act protects homeowners from claiming this as income; however, the protection does not extend to rental properties.
Credit Rating Factors
Foreclosures can have a major effect on your credit score. If you already have impaired credit due to late payments or missed payments, then the decrease may not be that noticeable, but you can expect a significant decrease if your credit is moderately good. If you plan on buying a car or obtaining a line of credit after a foreclosure, be prepared for high interest rates or even a rejection. Of course, a good payment history will eventually overshadow a foreclosure, but it will take a long time.
Alternatives to Foreclosure
If you are having trouble deciding the best course of action regarding your property, there are some alternatives you may want to consider. A deed in lieu of foreclosure is an option whereby the owner turns over the keys to the lender to avoid foreclosure. Your credit will still be affected, but this may help you avoid tax repercussions, depending on how the lender reports the transaction to the IRS. Another option is a short sale. A short sale is when a property is sold for less than the mortgage value. Short sales are not as damaging to your credit as a foreclosure, especially if the lender accepts the proceeds from the sale as payment in full for the loan and reports this to the credit agency.
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