The impact of a foreclosure on a homeowner can be financially devastating and affect the owner's credit scores for a decade. The ability of a lender to go after a homeowner's other assets, including retirement accounts, depends on the state, as each has its own foreclosure and lien laws.
The Foreclosure Process
Each state dictates the laws that lenders have to follow to foreclose on a property, including the timing of notices and the ability of the lender to seize other assets of the homeowner if the sale of the foreclosed property does not cover the total loan balance and legal fees. In general, a lender can begin foreclosure proceedings when a loan is more than 60 days overdue, but most wait until it is 90 days late. The lender sends a letter of default, which is the official beginning of the foreclosure process. The homeowner has until the day of the foreclosure sale, which could be three to six months from the default notice, to catch up on all arrears to avoid the sale. In some states, the lender can go to court after the sale and obtain a deficiency judgment against the homeowner for any outstanding loan balance left after applying the sale proceeds. This judgment can be satisfied by seizing other assets of the homeowner or by garnishment of wages.
Retirement accounts set up under the Employee Retirement Income Security Act are completely shielded from all creditors. These accounts include 401(k) plans, SEP IRAs, SIMPLE IRAs and other employer-sponsored plans. Traditional and Roth IRAs, however, are not ERISA plans, and state law dictates whether creditors can seize them. In some states, such as Nevada, a set amount of IRA assets are protected, amounts above which are fair game for deficiency judgments. Seizure of retirement accounts can cause significant tax consequences to the homeowner.
Non-Recourse and One-Action States
Some states do not allow a lender to take any action against a borrower other than the foreclosure proceeding. These are called non-recourse states. The lender may foreclose on the property but cannot sue the borrower for the difference between the sale price and the loan balance or obtain a default judgment. In other states, lenders are allowed only one action against a borrower: a foreclosure or other suit. Most lenders choose foreclosure as it provides more immediate ownership of the property. These are called one-action states. In both these types of states, IRA and other assets of the borrower are completely protected from the lender. However, in states without such provisions, a lender may pursue both a foreclosure and a deficiency judgment.
In many foreclosure situations, a homeowner will choose bankruptcy to halt the foreclosure. In a Chapter 7 bankruptcy, the debtor often has few assets and a judge will decide how to distribute those assets to debtors. If the debtor is delinquent on his mortgage payments, the property will likely be turned over to the lender. In a Chapter 13 bankruptcy, all creditor actions against the debtor must cease and a judge works out a repayment plan with the creditors. Often a homeowner can keep the house in a Chapter 13 and restructure payments with the lender. Federal law protects all IRA accounts up to $1 million from being distributed in a bankruptcy, regardless of the state the debtor lives in.
- RealtyTrac.com: 1.8 Million U.S. Properties With Foreclosure Filings in 2012
- New York Times: Protecting Retirement Accounts From Creditors
- Entrepreneur: How the New Bankruptcy Law Affects Your IRA
- ForeclosureListings.com: How Soon Can a Mortgage Company Foreclose?
- HELOC Basics: List of Non-Recourse Mortgage States and Anti-Deficiency Statutes