Default on HELOC may bring tax bill

Question: Four years ago, we bought a new home in Tucson with a first mortgage loan. The real-estate market was still booming at that time, and by the time we moved into the home there was an additional $40,000 in appreciation. We took out a $40,000 home-equity line of credit. We used this $40,000 to buy a new car and to pay off our credit cards.

Our home is now underwater by potentially $80,000 and we can no longer afford to make the payments on our first mortgage loan.

If we stop making payments both on our first mortgage loan and on the $40,000 HELOC, when will the foreclosure occur? Will our wages be garnisheed? Would we be responsible for any income taxes if the first mortgage or the HELOC don't get payment of their loans?

Answer: If the first mortgage loan forecloses, you generally would not have liability for any deficiency. Until the actual foreclosure sale, which you should attend, you will have to keep the home in reasonably good condition, which means also that you must keep in effect the homeowner's insurance policy.

The $40,000 HELOC will not foreclose, but you will get a judgment against you for $40,000, and the lender can garnishee your wages and take other collection action.

As for taxes, you will have no liability on the potential $80,000 debt forgiveness because there is no income tax on debt forgiveness of a mortgage loan used to purchase a primary residence, or to make improvements such as landscaping or a new roof to a primary residence.

Since the HELOC was not used to purchase or make improvements to a primary residence, if the HELOC lender gets less than $40,000, you owe taxes on the difference between the amount paid and the full $40,000.


by Christopher Combs The Arizona Republic Apr. 13, 2011 12:00 AM




Default on HELOC may bring tax bill