By Harvey S. Jacobs March 6, 2010

As if losing one’s home in a foreclosure or short sale were not already sufficiently traumatic, many former homeowners are learning that the day they turn in their keys may be only the start of an even more prolonged housing-induced misery.

Among many homeowners, there is a widespread misconception that once the house goes, so goes the debt. This is not true. Even if the homeowner loses his home to a foreclosure sale or short sale or gives his home back to the lender by a deed in lieu of foreclosure, the promissory note signed at the settlement remains a valid and legally binding obligation. That note requires the borrower to pay the lender all principal, interest and fees, regardless of what happens to the home.

Legally, the home is merely the collateral securing the repayment of that note. So even though the homeowner loses possession of his home, he remains obligated to repay the remaining principal balance of the note, all outstanding interest, late charges, and any other fees and costs incurred by the lender. These “other fees and costs” in a foreclosure scenario often amount to many thousands of dollars, including attorneys’ fees and costs, the cost of advertising the foreclosure sale, and trustee or auctioneer fees (often equal to 5 percent of the successful bid at the foreclosure auction).

These other fees and costs are recoverable by the lender under the terms of its note, mortgage or deed of trust. Any money received at the foreclosure auction will be deducted from the total amount due the lender. The difference between the total amount owed and the amount recovered at the foreclosure auction is called the deficiency amount.

When all is not forgiven

Many lenders are now aggressively chasing borrowers after a foreclosure, short sale or deed in lieu of foreclosure and obtaining what is called a deficiency judgment against them. These judgments are enforceable by courts in virtually all states. The judgments typically survive for 12 years and can be renewed by the holder for additional 12-year periods, potentially plaguing deficient borrowers long after their former home has become a distant memory.

Deficiency judgments are obtained by lenders in a number of ways. In a short sale, the lenders ask anxious short sellers to sign a letter acknowledging that, in order to agree to the sale terms, the lender expects the borrower to make good on the deficiency amount. Sellers, desperate to sell and move on with their lives, often sign these acknowledgment letters, which can then be easily converted in court to a deficiency judgment. Thus, these short sellers find themselves jumping from the frying pan into the fire.

A homeowner negotiating to deliver the home back to the lender by a deed in lieu of foreclosure should try to negotiate a forgiveness of any deficiency amount based on the fair market value of the home and the amount owed to the lender.

Try to persuade the lender not to report the deed-in-lieu arrangement to the credit reporting bureaus. In a foreclosure scenario, lenders can obtain the deficiency judgment by filing another lawsuit or asking the judge in the foreclosure proceeding to enter a monetary judgment against the homeowner for the deficiency amount.

Enter the IRS

Even when a lender agrees not to collect the deficiency amount, this benevolence may create another kind of misery. Lenders forgiving deficiency amounts must report that debt forgiveness to the Internal Revenue Service and to the homeowner on IRS Form 1099-C. Forgiveness of debt is essentially income, and income is taxable. Thus, borrowers who had the good luck to borrow from benevolent lenders willing to forgive debt may, under certain circumstances, face a tax bill from Uncle Sam for this “phantom” income.

However, under the Mortgage Forgiveness Debt Relief Act of 2007, taxpayers may exclude from income certain debt forgiven or canceled on their principal residence. This exclusion applies to the discharge of “qualified principal residence indebtedness,” or any debt (including refinanced debt) incurred in acquiring, constructing or substantially improving a principal residence and that is secured by the principal residence.

This exclusion is complex. The IRS has published no fewer than five publications dealing with the issue. Homeowners who have had debt forgiven should consult a competent tax preparer to determine whether the forgiven debt will be tax-free.

So what can desperate homeowners do? First, accept and open all mail from the lender or any court with jurisdiction over the matter. These letters are nothing personal. Lenders are required by law to contact delinquent borrowers several times by various means. The letters provide homeowners with notice of their legal rights.

Second, homeowners should attend all court hearings affecting their homeownership rights or right to defend against a deficiency judgment. If a homeowner does not understand these rights, he should seek legal advice.

Most state and county bar associations and law schools have established legal clinics to assist distressed homeowners. One of the best of these is Civil Justice ( which serves residents of Virginia, Maryland and the District. The Maryland State Bar Association, in partnership with the Maryland Legal Services Corp., has created the Foreclosure Prevention Pro Bono Project through the Pro Bono Resource Center of Maryland ( These organizations can review a homeowner’s case to determine whether he has any available defenses to a foreclosure, and, if so, they will attempt to match the homeowner with pro bono legal counsel.

Harvey S. Jacobs is a real estate lawyer with Jacobs & Associates Attorneys at Law in Rockville. He is an active real estate investor, developer, landlord, settlement attorney, lender and Realtor. This column is not legal advice and should not be acted upon without obtaining your own legal counsel. Contact Jacobs at (301) 417-4144, or