Strategic mortgage defaults could mean tax liabilities

I read some great advice about defaulting on your mortgage on Clark Howard’s website today:

Defaulting on a cash-out refi — the kind where you used the money to buy a boat, a car or take a vacation — is subject to a tax burden. Read more from Strategic mortgage defaults come with strings attached.

North Carolina is an anti-deficiency state. A deficiency is what happens after a bank forecloses on your property  and then sells it to recoup the amount it’s owed but fails to collect the full amount. The shortage is called a deficiency. In NC, a purchaser is not required pay any deficit allowing them to walk away from a property without owing a deficiency judgment. However, Anti-deficiency laws typically don’t provide protection for second mortgages or home equity lines.

According to North Carolina’s New Anti-Deficiency Statute:

…the loan is for the purpose of purchasing the dwelling, constructing, repairing, rehabilitating, remodeling, or improving the dwelling or the real property on which it is located, refinancing an existing obligation secured by the same real property, or consolidating existing consumer debts into a new home…

Notice that buying a car with your equity line is not mentioned. That’s part of what Clark Howard is telling you to watch out for.

According to the IRS website:

Here’s a very simplified example. You borrow $10,000 and default on the loan after paying back $2,000. If the lender is unable to collect the remaining debt from you, there is a cancellation of debt of $8,000, which generally is taxable income to you.Read more from Home Foreclosure and Debt Cancellation on the IRS.gov website.

I hope this is helpful!