I Have an Investment Property and Want to Let It Foreclose -- Will This Affect My Primary Home?
If you obtained a residential mortgage loan to finance your investment property, a foreclosure will not directly impact your primary residence. Residential mortgage liens are only attached to one property. So if a bank forecloses on your investment property, it cannot place a lien or otherwise make any claims on your primary residence. Even if both properties are financed by the same bank, your primary residence will be safe. That said, there are serious consequences to letting a house go into foreclosure. It should not be used as anything but a last resort.
Commercial Loans Work Differently
Residential mortgage loans, as obtained through agencies such as Fannie Mae, Freddie Mac or FHA, only attach a lien to a single property. But if you structured your financing as a commercial loan, it is more complicated. Commercial loans are attached to an individual or an entity rather than a property. Sometimes multiple properties are listed as collateral for a single loan. If you hold your properties in the name of a trust or an LLC, or if you otherwise connect your properties to a business you own, then it is likely that you have a commercial loan. Check the original loan note if you have any doubt. If your primary residence is used as collateral, it will be clearly stated.
Serious Financial Ramifications
Even if your primary residence is not directly at risk, the bank that foreclosed on you may sue you to recover the “deficiency” between the amount owed on the foreclosed mortgage and what they were able to get from the foreclosure sale. The bank would weigh the potential collection amount against the cost of a deficiency lawsuit, so they may let it go. But if it does sue, it could force you into bankruptcy a short time after your foreclosure goes through. Even if you are not held liable for a deficiency, the IRS may charge you taxes on the amount of the mortgage the bank was never able to recover.
Foreclosure Will Hurt Your Credit
A foreclosure also severely limits your financial options in the future. Once you have a foreclosure on your record, it will become nearly impossible to obtain any new mortgage, either through a refinance or new purchase. Most loan programs and mortgage investors require at least three years to have passed after a foreclosure, with some requiring an even longer seasoning period, before issuing another mortgage. Even streamlined refinancing will be held up by a past foreclosure on another property.
Short Sale May Be Better Option
If you owe more on your investment property than it is currently worth, look into the possibility of selling it via a short sale rather than letting it go into foreclosure. For example, say you owe $250,000 on the property, but can only get interest from a buyer for $200,000. You would apply to the bank to allow you to sell it for $200,000. It is in their interest to cooperate, seeing as that is the true market value for the house, and it saves them the legal and administrative costs of a foreclosure. Talk to a Realtor in your area who specializes in short sales. Although you still will be unable to get a new mortgage loan for at least three years, the negative credit impact of a short sale is much less severe than a foreclosure. Letting any house go into foreclosure, whether a primary residence or an investment property, should only be an absolute last resort. Even if your primary residence is not directly at risk, the financial consequences will be with you for years to come.
With more than a decade of experience, Gregory Erich Phillips is a trusted expert on real estate and mortgage financing. As an author, Phillips is known for his writings on economics, personal finance, religion, politics and culture.