Falling behind on your mortgage impacts your finances in several ways. Your first hit goes on your credit report where you start showing past-due balances lowering your credit score. If you never bring the payments back to green, the bank may begin foreclosure proceedings, which could ultimately lead to a deficiency judgment. Regardless, whether you already went through foreclosure or just owe last month’s bill, your tax refund is safe from garnishment by your mortgage company, until you deposit it in the bank.
A mortgage company cannot garnish your tax refund unless you deposit the refund in the bank after you're already subject to a deficiency judgment.
A Mortgage Company Cannot Garnish Your Tax Refund
The good news is that no private creditor can garnish a tax refund. Private creditors are creditors that are not the government, so that includes banks that hold mortgages. Because the IRS is a government entity, it is entitled to sovereign immunity under the U.S. Constitution, Article III, Section 2, which means that it is immune from suit. Immunity from suit means that the IRS cannot be subject to legal process unless it waives its immunity, and a garnishment action is legal process. Only federal and state government agencies, such as the Social Security Administration or the IRS itself, can garnish a tax refund.
Who Can Garnish Your Tax Refund
The Internal Revenue Service does offer a refund offset program to recover monies owed. The catch is the offset program is only available to local, state and federal municipalities to recover past-due government debts. The IRS may take your refund for back child support or defaulted student loans, but not for a private debt such as a defaulted mortgage balance. However, once the refund hits your bank account, sovereign immunity no longer applies, and it can be garnished.
Tax Consequences of Foreclosure on Rental Property or Residential Property
Homeowners who already finished foreclosure often face one of two outcomes: forgiven debt or a deficiency judgment. Your foreclosure tax liability will depend upon whether the remaining debt is forgiven. In many states, when a bank uses a non-judicial foreclosure, it cannot pursue a judgment for the remaining balance after the house is sold at auction. Instead, the balance is written off as forgiven debt. The IRS considers forgiven debt to be taxable income and treats it as such. The lender will issue you a Form 1099-C for you to report the debt forgiveness as income. If the bank forgives the debt, your post-foreclosure tax refund may be less than expected. Increasing your taxable income increases your tax burden.
On the other hand, if your mortgage company forecloses and does pursue you for a deficiency judgment, once a money judgment is obtained, the bank can start looking to your bank accounts for post-judgment execution as permitted by the law of your state.
Bank Levies to Satisfy Deficiency Judgments
Deficiency judgments come at the conclusion of a judicial foreclosure. When the lender takes you to court, it may request a judgment for the balance owed after the house is sold at auction. The lender may pursue several remedies including wage garnishment and bank levies. Once your refund money hits your bank account, the IRS has no control over it. If your mortgage company levies your bank account, it could take your refund to cover the judgment balance.
Considerations after Foreclosure
Contact your lender as soon as possible to work out a payment arrangement to make up the past-due balance. Homeowners facing foreclosure may qualify for a loan modification program to save the property. Most mortgage lenders work with distressed homeowners to find solutions to a financial hardship. If you have a deficiency judgment, the mortgage company may set up payment arrangements to pay the balance instead of pursuing forced-payment options such as garnishment or levies.
- Internal Revenue Service: Home Foreclosure and Debt Cancellation
- Consumer Financial Protection Bureau: Can a Debt Collector Garnish My Bank Account or My Wages?
- The Law Dictionary: Can a Mortgage Company Take Your Tax Returns?
- Money Crashers: 4 Reasons the IRS Can Seize Your Income Tax Refund Money for Debt
Leigh Thompson began writing in 2007 and specializes in creating content for websites. She has been published online in various capacities. Thompson has an associate degree in information technology from the University of Kansas and is working on a bachelor's degree in business and personal finance.