By Ilyce Glink and Samuel J. Tamkin
Q: I am a retiree. My income is from Social Security and a small pension. Ten years ago, I was a cosigner on a mortgage. The homeowners have decided to put their home up for a short sale.
I've never lived in the dwelling and never received any benefit from the house (in taxes or otherwise). Can you advise me what will be the outcome of the short sale, and what I can do to protect myself? I do not own a home, or have any assets of value. I do own my car, which is five years old.
A: When you "help" people buy a home, obtain a student loan, buy a car or obtain a credit card and you cosign with them, you and they are equally responsible when it comes to the duties and obligations required under the documents.
In your case, you helped these other people buy or refinance their home and cosigned the note and mortgage. You and they agreed to repay the loan to the bank. It does not matter if you don't live in the home, don't get any benefit from the ownership of the home or wouldn't get any profits from the sale of the home. What does matter for you is that you are personally responsible for the repayment of the debt owed the lender.
When the person you helped years ago borrowed that money, the bank expected them or you to repay the debt. If they didn't pay the debt back, the bank could come after you. You weren't guaranteeing the debt; you were borrowing the debt with them.
Having said all that, when the people you helped sell their home in a short sale, they will need to get the lender to agree to the terms of the short sale. If the short sale is approved, the approval can come in two forms. The lender could agree to the short sale terms and agree to forgive the repayment of any of the balance of the debt still owing -- the deficiency. On the other hand, the lender could agree to the short sale on the condition that the balance of the debt must be repaid over time. While there could be other combinations, these are the two most likely.
If the lender agrees to waive the deficiency, that deficiency is considered a taxable gift from the lender to the person you helped and to you.
However, we assume that, over the years, the bank didn't issue 1099 mortgage statements to your Social Security number. The person you helped should have received those statements and should have taken any mortgage interest deduction on their federal income tax statements.
We suggest that you make sure that, as part of the short sale process, the people you helped require the lender to issue the 1099-C to them and their Social Security numbers. If this can be arranged, the impact won't be as hard on you with the short sale.
Let's say that the deficiency is $100,000 and if they and you both have received 1099 statements in the past attributing the interest paid half to you and half to the other signers, you might now expect that they would treat the 1099-C. While lenders may not ordinarily apportion the amounts on their filings, it would be wise for you to find out now, if you don't already know, how any prior forms were sent out and what Social Security numbers were used.
Given this $100,000 example, if the release of indebtedness is one-half attributed to you, you'll have an extra $50,000 of income for the year in which the short sale occurs. Given certain assumptions, you might have a bill to pay the IRS of $10,000 to $15,000 on this phantom income. This is what you are trying to avoid.
Finally, on a different front, helping them borrow money also means that your credit history was used for the loan application. If they have been good borrowers all along, your history should not have been adversely affected by their loan. Now that they plan to short-sell the home, your credit history and credit score will be hurt. Your credit history will show that you failed to pay off a mortgage loan debt according to the terms of the loan, and that blemish will remain on your credit history for some time. Your credit score will also take a hit.
While these impacts on your credit score and history are negative, they may not affect you much in the future. However, if you decide to sell your car and buy a new one, your lower credit score could affect your ability to get the best terms and rates. You may come across some other issues when you apply for store credit cards and some types of insurance. Nonetheless, over time your credit history and your credit score will improve.
(Ilyce Glink is the creator of an 18-part webinar and ebook series called "The Intentional Investor: How to be wildly successful in real estate," as well as the author of many books on real estate. She also hosts the "Real Estate Minute," on her YouTube.com/expertrealestatetips channel. If you have questions, you can call her radio show toll-free (800-972-8255) any Sunday, from 11a-1p EST. Contact Ilyce and Sam through her website, http://www.thinkglink.com.)
(c) 2014 ILYCE R. GLINK AND SAMUEL J. TAMKIN. DISTRIBUTED BY TRIBUNE CONTENT AGENCY, LLC.