Mortgages are contractual agreements between lenders and borrowers. If you don't repay a mortgage, your lender can sell your home to settle the balance owed. If you're not a signer on the loan, you're generally not liable for repaying the debt. This changes, however, if you live in a community property state and the defaulting borrower is your spouse. In this instance, a foreclosure can hurt your pocketbook in several ways.
Laws in many states enable one owner of a property to finance a home. The borrower in question signs the actual loan note and agrees to repay the mortgage. The other owners are usually required to sign the mortgage as owners who are consenting for the borrower to take on the loan. Basically, it's not your debt, but you're agreeing to allow the lender to use your home as collateral for the loan. If the home goes into foreclosure, it doesn't hurt your credit score, because you're not responsible for repaying the debt. You do lose your home, but your involvement in the property ends there — unless you're married to the borrower.
In states with community property laws, you normally have ownership rights to property if your spouse's name is on the title. You're also liable for your spouse's debts. Rules vary between states and, in many places, you're only liable for the debts that your spouse incurred after you got married. This means that a lender could attempt to sue you and your spouse to settle a delinquent mortgage even if your name isn't on the title of the house or the loan. Depending on your state's laws, a lender may be able to garnish your joint bank accounts to settle the unpaid debt.
Recourse Versus Nonrecourse
In some states, many types of mortgages are nonrecourse loans. This means that the lender can foreclose on the home but take no further action against the borrower if the foreclosure sale fails to settle the debt. Other states have recourse laws that allow a lender to sue you for any outstanding balance owed on the loan after the foreclosure sale. Lenders are often able to wait several years before pursuing you in court for a past-due debt. If you live in a state with community property laws, this means a lender could come after your joint bank accounts several years after your spouse's mortgage goes into foreclosure.
If a lender takes a loss as the result of a foreclosure, the Internal Revenue Service regards that loss as a cash gift to the delinquent borrower. This sum of money gets added to the borrower's taxable income. As a nonborrowing owner of a foreclosed home, this tax bill won't affect you unless the borrower is your spouse and you file your taxes jointly. In this case, you end up having to pay taxes on the debt write-off, even though you technically didn't benefit from the write-off since the mortgage wasn't your own debt.
- IRS: Collection of Taxes in Community Property States
- U.S. Department of Housing and Urban Development: Foreclosure Process
- NOLO: Debt and Marriage: When Do I Owe My Spouse's Debts?
- Investopedia: What is the Difference Between a Non-Recourse Loan and a Recourse Loan?
- The Balance: The Tax Consequences of a Foreclosed Home
- Hemera Technologies/AbleStock.com/Getty Images
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- Tax Effects of Defaulted Promissory Notes
- What Is a Puisne Mortgage?
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