Mortgage Debt Relief: How You Can Benefit

Mortgage debt relief is sometimes the most likely recourse for someone who cannot pay off all their debt. Some lump it into the same general category as canceled debt and mortgage forgiveness debt relief. They all tie into the same concept: debt forgiveness and its taxable consequences.

When you say “mortgage debt relief,” one of the first issues that comes to mind for most people is the Mortgage Forgiveness Debt Relief Act of 2007. This government-instituted act provided tax benefits and exclusions for people who were once under the burden of a mortgage loan but were relieved of that burden for one of a number of purposes.

What is Mortgage Debt Relief?

Let’s look at mortgage debt relief and its taxable consequences of mortgage debt relief from the ground up. First of all, why would you get mortgage debt relief? It’s unfortunate, but many United States citizens treat their homes like an ATM. They take out a mortgage against the value of their homes to extract instant cash to use for other purchases. Some buy vacation homes, tickets for a fancy cruise or a boat. Thus, the mortgage was not taken out because the homeowner needed the money; they wanted the money to purchase other high-ticket items.

If your finances became such that you could no longer make payments on the mortgage to pay the bank  or other lender back all that money, your debt might be canceled. In this case, mortgage debt relief does not apply because you did not use the money to renovate or other improve the home. You used it for extraneous desires. So what does this mean on for your taxes?

This means that the forgiven debt can now be taxed as income. That’s right. Even though you didn’t earn that money, it is still income because you received the money and did not use it for tax-exemptible purposes. So if you mortgaged hundreds of thousands of dollars, you might owe quite a bit in income tax. The income tax owed varies by state, of course.

How Mortgage Debt Relief Applies to You

Now let’s look at a scenario where mortgage debt relief does apply. Home foreclosure is a common reason. Let’s assume that you had a mortgage on your home that was worth ten times your yearly income. That sort of mortgage, by its very nature, takes decades to pay off, unless something changes in your financial status that makes you more able to pay it off.

Using this scenario, let’s say that one of the worst nightmares just occurred: you haven’t been keeping up with your payments, and the bank who owns the home and funded your mortgage has decided to foreclose on you. What happens to the debt that you still owe to the bank? Does mortgage debt relief apply?

Fortunately, yes. That’s where mortgage debt relief comes in; that debt is forgiven, cancelled out. You no longer owe a penny on it. Many homeowners would still be stinging after getting their home taken away, but on the bright side, they don’t owe any more money on it.

Luckily for you, as long as the mortgage was worth less than two million dollars, you don’t owe any tax on it, either. Because you lost your home, you are exempt from owing income tax on the money. The same is true if you lost your home or defaulted on a mortgage because you went bankrupt.

Now let’s look at the math involved in mortgage debt relief. You might be asking yourself, which part of the loan do I have to pay tax on? The part that I already paid back, or the part that I haven’t paid back? Put simply, you pay tax on the money that you did not pay back; that is, the money that you used to purchase something else but never returned to the lender.

Here’s an easy equation to follow. Let’s say you took out a loan for $25,000.00. You were able to pay back $5,000 before you defaulted or the loan was canceled. That means you got to keep (i.e. spend) $20,000.00.

That $20,000.00 was just added to your total taxable income for the year. In some states, income tax is as high as 15%. If you live in such a state, you would end up paying $3,000.00 in tax. If you qualified for mortgage debt relief, you’re breathing your own sigh of relief right now.

There are other conditions under which you can apply for mortgage debt relief. Homes are not the only case where some sort of restructuring or forgiveness is available. Student loans sometimes fall under this category, as does credit card debt. However, they oftentimes do not, according to the IRS, as it depends on what circumstances the debt was canceled and how your loan was set up to begin with.

The whole objective of getting a mortgage is to someday, hopefully, pay it back to the lender, not take advantage of mortgage debt relief. However, if you cannot do so, you might qualify for mortgage debt relief of some sort to help you avoid paying the taxes on the loaned money that you no longer have.

 

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