Even as we see further evidence that the economy is improving in recent months, many Arizona homeowners remain significantly "under water" (i.e., owing more to the bank than the fair market value of their home).  For a variety of reasons, including unemployment, unanticipated expenses, and loan rate resets, underwater homeowners may no longer be able to make their monthly loan payments.  At the same time, such homeowners are unable to sell their homes for enough money to pay off the outstanding principal balance of their loan, leaving such homeowners wondering if they should just walk away and let the lender foreclose on the home.  In fact, Arizona homeowners have several options in such a circumstance, most commonly including foreclosure, a short sale, and personal bankruptcy, but it is important to weigh implications such as personal liability for deficiencies, taxes resulting from loan forgiveness, damage to one's credit score, and the ability to buy another home in the future, before determining what course of action to take.

            The first option is foreclosure, which has substantial, long term consequences for homeowners. A foreclosure of a home may create personal liability for a deficiency, which is the difference between the outstanding balance of the home loan and the amount the home is sold for at the foreclosure sale. Arizona law generally protects residential borrowers from personal liability for deficiencies if the subject loan secures a "purchase money" obligation, that is, a loan given to secure payment of the balance of the purchase price of a home.  However, Arizona's anti-deficiency statutes have several complicated exceptions and do not apply to refinanced loans and second mortgages (including home equity lines of credit).  Thanks to the Mortgage Forgiveness Debt Relief Act of 2007, homeowners will not face tax liability for up to $2,000,000 of debt forgiven by lenders in connection with a foreclosure on a borrower's primary residence this year or next.  Even if a homeowner faces no personal or tax liability in connection with a foreclosure, a foreclosure will severely and adversely impact a borrower's credit score and ability to purchase another home for many years.

The most common alternative to foreclosure is a short sale, in which the lender consents to the sale of a home for less than the outstanding balance of the loan.  A short sale can be a very difficult process and time consuming to negotiate with a lender, but the upside is that a short sale will typically have much less impact on a borrower's credit score and ability to purchase another home in the future.The Mortgage Forgiveness Debt Relief Act of 2007 is applicable to debt forgiven by lenders in connection with a short sale as well.  However, it is critically important to keep in mind that borrowers are not released from personal liability for a deficiency following a short sale unless the lender specifically agrees in writing to such a release.  Unfortunately, lenders are not always willing to release borrowers from liability for a deficiency in connection with a short sale, but it may be possible to negotiate a compromise, such as a promissory note for a lesser portion of the remaining balance of the loan.  

            An option for homeowners who face personal liability for a deficiency in connection with the loss of a home is personal bankruptcy. Personal liability for deficiencies may be forgiven in bankruptcy and none of the debt forgiven in bankruptcy is taxable.  However, bankruptcy will also significantly impact a borrower's credit score and ability to purchase another home for many years, so such a determination must be carefully weighed

            These are complicated issues that should be discussed with competent counsel familiar with real estate law and bankruptcy law.  For more information, please contact Stu Pack or Walter Howl at (602) 595-6951 or email them at stuart.pack@naglelaw.com or walter.howl@naglelaw.com.