The Emergence of Post-Traumatic Foreclosure Disorder

By William Hudson

The daily calls haunt Neil Garfield and his staff.  Homeowners facing foreclosure vacillate through a predictable cycle of fear, helplessness, betrayal, confusion, powerlessness and sometimes the desire for retribution. Some callers display a pressured, almost manic-like urgency to correct their situation while some are so beaten down they are complacent. There are also the calls from homeowners who learn that they waited too long- and there is nothing else that can be done. The feeling of hopelessness and despair are palpable.  Many homeowners will prevail against their loan servicers and many will lose, but all will come away from the experience emotionally altered.

The way people react to foreclosure varies depending on personal factors including resiliency, family support, other resources available to them and the expectation of recovering from the set back. These factors are usually complicated by the degree of injustice suffered at the hands of their loan servicer or the judicial system. The people who have had loan modifications revoked, have discovered evidence of fraud, have had their homes broken into by the banks, or have been victims of a bank deliberately engineering a default through lies and disinformation- tend to be the most impacted. It is one thing to fall behind on your mortgage and go through a relatively quick foreclosure, but quite another when you spend years in litigation while the bank’s attorneys play unethical games and engage in illegal activity often with the court’s complicity.

If you have gone through a foreclosure or are in the process, you may be suffering from “Post-Traumatic Stress Disorder (PTSD)”.  But perhaps it is time to coin a new disorder specifically for those who have gone through foreclosure called “Post Traumatic Foreclosure Disorder (PTFD)”.  Although it is not an actual syndrome, perhaps it should be. Although the symptoms would reflect those found in Post Traumatic Stress Disorder- they would be tailored to the experience of foreclosure.  PTSD is a disorder that can be debilitating and tends to affect people who have encountered life events that fall outside the normal experience. Soldiers, survivors of natural disasters and people who have been victimized often have PTSD.  Perhaps Post Traumatic Foreclosure Disorder should be added to the DSM-5, also known as the Diagnostic and Statistical Manual of Mental Disorders- in light of the fact that there are millions of Americans suffering from the disorder after going through foreclosure. The affected might not understand why they can’t “get over it” and why years after the foreclosure- they don’t feel “right”. Perhaps mental health workers should take notice of the mental health toll that occurs with foreclosure and the aftermath. This article is not medical advice, is not for medical diagnosis- but is a brief exploration of foreclosure’s impact on mental functioning.

For creative purposes I will refer to symptoms of the fictitious Post Traumatic Foreclosure Disorder as a disorder similar to Post Traumatic Stress Disorder. However, if you seek medical assistance please don’t state you may have Post Traumatic Foreclosure Disorder- although most health care workers will understand what you are trying to say.

After a stressful event like foreclosure, symptoms may start within three months of the onset of a traumatic event, but sometimes symptoms may not appear until years after the event. The symptoms of Post Traumatic Disorders that result from foreclosure may cause significant problems in social or work situations and in relationships; and in overall life functioning.

PTFD symptoms might be grouped into four types similar to those in diagnosing Post-Traumatic Stress Disorder (an actual psychiatric disorder): intrusive memories, avoidance, negative changes in thinking and mood, and/or changes in emotional reactions.

Intrusive memories

Symptoms of intrusive memories may include:

  • Recurrent, unwanted distressing memories of foreclosure, lawsuits, key events
  • Feelings of guilt for allowing the foreclosure to occur and impact on family
  • Extreme anger about the bank’s tactics or the court’s refusal to enforce the law
  • Upsetting dreams about the traumatic event, waking up with panic attacks
  • The destruction of reputation especially if the foreclosure was caused by layoffs, health issues, etc.
  • Replaying the details of the foreclosure, the lawsuit, the loss of home or a betrayal event
  • Severe emotional distress or physical reactions to something that reminds you of the event including panic and anxiety attacks, depression, thoughts of suicide, etc…


Symptoms of avoidance may include:

  • Trying to avoid thinking or talking about the event despite the huge impact of the foreclosure
  • Refusing to drive by the home or even drive through the part of town where the home was located
  • Avoiding places, activities or people that remind you of the foreclosure including courts, attorney offices or even driving by a building with the name of the bank
  • Refusing to purchase a new home because of servicing fears

Negative changes in thinking and mood

Symptoms of negative changes in thinking and mood may include:

  • Negative feelings about yourself for causing the foreclosure (even if it was beyond your control)
  • Negative feelings about attorneys who may have poorly defended the case or didn’t deliver on promises
  • Anger over the courts that blatantly ignored evidence and made erroneous presumptions that were untrue- or simply denied the homeowner due process
  • Inability to experience positive emotions- a feeling that the entire system is rigged
  • Feeling emotionally numb- a sign of depression
  • Lack of interest in activities you once enjoyed
  • Hopelessness about the future- the feeling you will never recover from the financial setback
  • Memory problems, including not remembering important aspects of the traumatic event
  • Difficulty maintaining close relationships

Changes in emotional reactions

Symptoms of changes in emotional reactions (also called arousal symptoms) may include:

  • Irritability, angry outbursts or aggressive behavior- the feeling that you must protect yourself
  • Always being on guard for danger- trust is diminished in people and the system
  • Overwhelming guilt or shame
  • Self-destructive behavior, such as drinking too much or driving too fast
  • Trouble concentrating
  • Trouble sleeping
  • Being easily startled or frightened
  • Shame- another negative and paralyzing emotion

These are only some of the symptoms that may manifest.  Even if a mental health crisis does not result in a traumatic disorder, foreclosure is a stressful event.  Although not all people will experience stress disorders, other mental health disorders may surface include anxiety disorders, depression, sleep disorders, eating disorders and substance abuse issues.

It is devastating that banks are being permitted to create not only a mental health crisis but a medical crisis as well. The threat of losing a home can be stressful enough to make a homeowner physically ill. Researchers at Princeton have shown a correlation exists between foreclosure rates and people’s health with an increase in hypertension, diabetes and anxiety-related visits (Kalita 2011). The researchers also found that suicide attempts rise in proportion to the increase of foreclosures.

Foreclosure increases the number of mental health disorders and is one more consequence of the American Banking cartel. It has been found that a health crisis or a job loss is the main reason for foreclosure and yet foreclosure further exacerbates health issues and unemployment (Robertson et al, 2008).  Although stress is a normal part of life, high levels of anxiety, shame, uncertainty, fear and financial devastation contribute to physical and mental illness. However, the long term deleterious consequences of foreclosure are still unknown.

Regardless of their psychological health before the crisis, high degrees of stress affect both grownups and children and last for extended periods. Such a situation can develop into enduring psychiatric ailments that become lifelong ailments if not properly managed (Lashley et al., 2009).  Unfortunately no long-term studies have been done on the mental health of children that go through the uncertainty and trauma of foreclosure. However, researchers have noted that children in afflicted households face the effects of foreclosure and associated financial problems, indicating that mental health practitioners need to develop workable strategies to empower family members to develop resiliency in managing their current economic reality. The children might exhibit psychiatric symptoms, or the impact might be evident in their emotional growth. Some children might develop social functioning difficulties or demonstrate sub-clinical levels of depression.  Foreclosure probably contributes to poor academic performance.  The long-term effects of foreclosure are simply not known at this time- but it appears that the prognosis is not good.  It is known that parents who are under severe stress are unable to parent at a high level.

Foreclosure also leads to other complications.  The humiliation of a foreclosure is broadcast for all to see by being posted on the internet or by nailing foreclosure notices to the front door for all to see. Foreclosure and bankruptcy were once relatively private affairs for the most part- but now families are shamed by Notices of Default displayed on the internet that will never disappear. When a person’s name is ‘googled’ the foreclosure entries are prominently displayed. The foreclosure posts may also impact future employment opportunities. Perhaps litigation should be passed that would remove all derogatory information about foreclosure seven years after the event. The fact that someone should live with a lifelong stigma because of an event that may have been beyond their control is unjust. It is easy to see why people remain traumatized after foreclosure.

The fact remains that the true health risks of foreclosure can’t be quantified. It isn’t only the foreclosure that is traumatic but the resulting fallout including deficiency judgments, IRS 1099 forms, relocation, divorce, loss of social standing, new neighborhoods, school changes, legal fees and credit score decimation. When a person loses a home, the center of their universe shifts from one of stability and permanence to one of instability and impermanence. The overall impact on society is detrimental. Many people with one-time short term financial setbacks could easily restructure their finances and cure any arrearage if the bank would simply help structure a modification or repayment plan in good faith.  However, this does not occur because a loan servicer is incentivized to foreclose not to modify the loan. Our elected officials have the power to reign in the big banks and to pass legislation to stop this insanity- but don’t. HAMP is one example of a program that was engineered to fail, and contributed to many detrimental mental health events.

A modification under the Home Affordable Modification Program is often more stressful than a foreclosure because there is no accountability or way to determine where you stand.  Meanwhile the homeowner cannot proceed with plans to stay in the home or make arrangements to move- they are caught in a never-never land type scenario waiting for the bank to make their decision.  A typical modification will put a homeowner through a process that is deliberately confusing, contradictory and set up to fail.  As the homeowner chases their tail submitting the paperwork again and again- they go through an emotional roller-coaster of hope and fear, that typically ends with a temporary success and ultimate defeat.

A homeowner might apply for a modification ten times over the period of a year before receiving a trial modification.  When they finally receive a letter of approval a mild euphoria sets in and they will go to great lengths to make their payments by certified mail and comply with all of the terms.  However, rarely is the loan modified.  What typically occurs is that while the servicer was taking payments from the homeowner, the bank was making plans to foreclose.  This is called dual-tracking.  Upon receiving notice that they didn’t qualify for some arbitrary reason- the homeowner will be thrown into a state of despair.  Quite often the homeowner will receive yet another offer to modify their loan that they just received notice that they didn’t qualify for.  The homeowner may go through several years of  these bad faith offers to modify.  There is simply no excuse to put a family through this frustrating and expensive process.  The government could easily pre-qualify people before offering a modification and do away with the emotional turmoil the current modification process entails.  It is almost like the bank has some sadistic motive towards homeowners who dared to fall behind on their mortgage.

Foreclosure isn’t a choice people make- it is a situation that is usually the result of other factors beyond the homeowner’s control. Over the past decade people have experienced difficult economic conditions including job losses, job insecurity, bank collapses, retirement fund destruction, market bubbles, financial insecurity and other events that have resulted in economic chaos and the dislocation of families. Soaring food, energy, and health care costs put financial strain on the average household, and coupled with the detrimental circumstances in times of economic uncertainty, those suffering through foreclosure might undergo increased stress exposure. However, it is evident that foreclosure is starting to lose the stigma it once had as the majority of the United States population live paycheck to paycheck and recognize that with one bad event like illness, job-loss or an emergency they might be filing foreclosure also.

Caner and Wolff (2004) stated that approximately 46% of American families have as little as $5,000 in liquid assets, including IRAs, which indicated some families are at the brink of financial disaster. In a survey of 60,000 homeowners, researchers for the Homeownership Preservation Foundation (Ackerman, 2010) found the following circumstances might put individuals at risk of foreclosure: 25% resulted from a health crisis; 32% resulted from a job loss; 50% had already missed two mortgage payments and 85% had already missed one; most had first-time home loans; almost all had no savings, no accessible credit, and few assets available in their extended families; most had already refinanced two or three times; and virtually all loans were less than 3 years old.

Researchers have found that the stress of foreclosure is exacerbated by the length of the process (sometimes taking 5 or more years to resolve), and the aversive procedures foreclosure entails.  The stress to families begins when they become delinquent on their mortgage and the bank starts the foreclosure process; the process itself varies substantially among different jurisdictions of the United States, ranging from several months to over eight years in some cases. If a homeowner chooses to litigate the foreclosure the homeowner will be subjected to high periods of stress, periods of waiting, and a rollercoaster of emotions as new events unfold.

Another consequence of foreclosure is the tendency to avoid banking relationships and the judicial system. Many homeowners voice their reluctance to become involved in any written contract after a foreclosure, with the new understanding that if a banking issue occurs the banks won’t play by the rules and the courts, almost by default, will rule in favor of the bank. The individual facing foreclosure may find that literally overnight they are immersed into an alter-reality of confusing legal terms, procedures and case law without a rudimentary understanding of the terminology being used. The legal experience of foreclosure simply compounds the trauma (the expense, not understanding what is happening, etc). Homeowners may depend on their attorneys for legal education- but very few attorneys have the time to explain basic legal procedure to every client. The homeowner who has always believed they could bring themselves up to speed on most topics quickly discovers that without a law degree they won’t be able to defend themselves.

Many clients who have successfully received a loan modification state they live in absolute fear of accidentally missing one payment or having another issue that may be used as an opportunity by the bank to force them into default. They say that after dealing with the bank bureaucracy and receiving conflicting answers provided by customer “service” agents they fear the problem will never be resolved. I spoke to a recent client that now records all conversations with her bank. Foreclosure isn’t just about losing a home- it causes a complete reevaluation of a person’s core beliefs about the goodwill of people and especially about their government who subsidizes the banks that break the law with impunity.

In conclusion, although Post Traumatic Foreclosure Disorder is not a recognized medical diagnosis, foreclosure can result in a trauma that manifests in conditions like Post Traumatic Stress Disorder and even physical illness.  It is important that people who are experiencing mental health complications from the overwhelming nature of losing a home seek professional assistance.  In time, the trauma of foreclosure typically fades and the homeowner rebuilds their life- but there is no doubt that the trauma of foreclosure takes an emotional toll.


When to see a doctor

If you have disturbing thoughts and feelings about a traumatic event for more than a month, if they’re severe, or if you feel you’re having trouble getting your life back under control, talk to your health care professional. Get treatment as soon as possible to help prevent PTSD or PTFD symptoms from getting worse.

If you or someone you know is having suicidal thoughts, get help right away through one or more of these resources:

Call a suicide hotline number — in the United States, call the National Suicide Prevention Lifeline at 800-273-TALK (800-273-8255) to reach a trained counselor. Use that same number and press 1 to reach the Veterans Crisis Line.

Make an appointment with your doctor, mental health provider or other health care professional.

If you know someone who’s in danger of committing suicide or has made a suicide attempt, make sure someone stays with that person. Call 911 or your local emergency number immediately. Or, if you can do so safely, take the person to the nearest hospital emergency room.


Ackerman, T. (2010, March/April). Foreclosure vs. homeless: Take a proactive approach. Facts and Findings. Retrieved from


Caner, A., & Wolff, E. N. (2004). Asset poverty in the United States: Its persistence in an expansionary economy. Levy Economics Institute of Bard College, Public Policy Brief, 76. Retrieved from – See more at:

Kalita, S. (2011, August 1). Tying health problems to rise in home foreclosures. The Wall Street Journal. Retrieved from 6.html?mod=WSJ_hp_LEFTTopStories

Lashley, M., Maudry, B., Jeffers, A. E., & Davis, D. E. (2009). Psycho-social impact of mortgage foreclosure. European Journal of Management, 9(3). Retrieved from

Mental health: Keeping your emotional health. (2002, October 1). American Family Physician, 66(7), 1287-1288. Retrieved from

Robertson, C., Egelhof, R., & Hoke, H. (2008, August 18). Get sick, get out: The medical causes of home mortgage foreclosures. Health Matrix, 18(65). Retrieved from



Non-Profit Lenders Step in to Provide Post-Foreclosure Modification

Editor’s Note: Principal reduction can be achieved in more ways than one. Here Non-profit Lenders see the clear opportunity to buy mortgages from dubious sources and then enter into new mortgages with the homeowner thus preventing eviction and restoring the homeowner to non-distress status.

The problem here is that title is not clear and eventually there is going to be a day of reckoning. The underlying theme here is that principal reduction is the ONLY way this mess will be cleared up and getting it right about WHO can sell a mortgage, execute a satisfaction of mortgage, or otherwise enforce or foreclose a mortgage is still in flux.
The reason is that it is in flux is that Judges and lawyers are just starting to get the the counter-intuitive idea that the finance sector actually set out to make bad loans because that was how they made money.
It’s not counter-intuitive if you realize that the real creditor is the investor who put up the money and all the rest are pretenders who pocketed a big portion of the proceeds of securities sale before funding mortgages. It is those pretenders who are “selling” and “enforcing” the “loans.”
My suggestion is that regardless of how and with whom you resolved your mortgage dispute, a quiet title action needs to filed naming all potential claimants in which a Judge declares the rights of the parties and confirms your title subject to whatever new mortgage or modified mortgage you executed. I don’t see any other immediate way to resolve the title problems
March 21, 2010

Finding in Foreclosure a Beginning, Not an End


BOSTON — Jane Petion lived in her home for 15 years and saw its value rise slowly, rise rapidly and, when the housing bubble burst, plunge at a sickening pace that left her owing $400,000 on a house worth closer to $250,000. Last June, her lender foreclosed on the property. The family received notices of eviction and appeared in housing court.

Then they discovered a surprising paradox within the nation’s housing crisis: Their power to negotiate began after foreclosure, rather than ending there.

In December Ms. Petion signed a new mortgage on her house for $250,000, with monthly payments of less than half the previous level. She and her husband now have a mortgage they can afford in a neighborhood that benefits from the stability they provide. A nonprofit lender made the deal possible by buying the house from her original mortgage company and selling it to her for 25 percent more than its purchase price — a gain to hedge against future defaults.

“It was exactly what we needed to get back on our feet,” said Ms. Petion, who works for a state agency. “We have income. But another bank, it would have been easy to look at our foreclosure and say, ‘I’m sorry, we have nothing for you now.’ ”

This counterintuitive solution — intervening after foreclosure rather than before — is the brainchild of Boston Community Capital, a nonprofit community development financial institution, and a housing advocacy group called City Life/Vida Urbana, working with law students and professors at Harvard Law School.

Though the program, which started last fall, is small so far, there is no reason it cannot be replicated around the country, especially in areas that have had huge spikes in housing prices, said Patricia Hanratty of Boston Community Capital. “If what you’ve got is a real estate market that went nuts and a mortgage market that went nuts, what you’ve got is an opportunity.”

Two years into the nation’s housing meltdown, and after hundreds of billions of dollars of federal rescue programs, government officials and housing advocates denounce the unwillingness of lenders to adjust the balances on homes that are worth less than the mortgage owed on them.

Research suggests that such disparity, rather than exotic interest rates, is the main driver of foreclosures, in tandem with a job loss or another financial setback. The financial industry lobbied aggressively to defeat legislation that would empower bankruptcy judges to adjust mortgage balances to properties’ market value.

That reluctance, however, eases after foreclosure, when lenders find themselves holding properties they need to unload, Ms. Hanratty said.

“We found, frankly, the industry wasn’t ready to do much pre-foreclosure,” she said. “But once it was either on the cusp of foreclosure or had been taken into the bank portfolio, banks really do not want to hold on to these properties because they don’t know how to manage them, don’t know what to do with them.”

Working with borrowed money, Boston Community Capital buys homes after foreclosure and sells or rents them to their previous owners, providing new mortgages and counseling to the owners, who typically have ruined credit. During the process the families remain in their homes. Since late fall it has completed or nearly completed deals on 50 homes, with an additional 20 in progress, Ms. Hanratty said. The organization is now trying to raise $50 million to expand the program.

Steve Meacham, an organizer at City Life/Vida Urbana, is one reason banks may be willing to sell their foreclosed properties to Boston Community Capital. When families receive eviction notices, his group holds demonstrations or blockades outside the properties, calling on lenders to sell at market value. It also connects the residents with the Harvard Legal Aid Bureau, whose students work to pressure lenders to sell rather than evict by prolonging eviction and “driving up litigation costs,” said Dave Grossman, the clinic’s director.

“So they’re being defended legally, and we’re ramping up the pressure publicity-wise,” Mr. Meacham said. “And B.C.C. came in; they had a part that buys properties and a part that writes mortgages. It wouldn’t work without all three.”

A focus of the program has been the working-class neighborhood of Dorchester, where home prices dropped 40 percent between 2005 and 2007, compared with a 20 percent drop statewide, according to research by the Federal Reserve Bank of Boston. Foreclosures and delinquencies there are more than twice the state average, the bank found.

In such neighborhoods, lenders and residents are hurt by evictions, which often leave vacant properties that invite crime and drive down values of neighboring houses, Ms. Hanratty said. “So it’s in the lenders’ interest to get fair market value as quickly as possible, and in the interest of the community to have as little displacement as possible.”

The program is not a solution for all lenders or distressed homeowners. After months of post-foreclosure negotiations with her bank, Ursula Humes, a transit police detective, is waiting for her final 48-hour eviction notice. Her belongings are in boxes.

Mrs. Humes owed $440,000 on her home; her lender offered to sell it to Boston Community Capital for $260,000. But after assessing Mrs. Hume’s finances, the nonprofit asked for a lower selling price, and the lender refused.

On a recent evening, Mr. Grossman of the Harvard law clinic counseled Mrs. Humes on her options. “This is a case that doesn’t have a happy ending,” Mr. Grossman said.

Mrs. Humes said, “I depleted my retirement account and everything I owned, but I’m still going to lose it.”

Many commercial lenders, similarly, would shy away from such a program because it involves writing mortgages for borrowers who have already defaulted once — a high risk for a small reward.

For other homeowners, though, the program is a rescue at the last possible second. Roberto Velasquez, a building contractor, lost his home to foreclosure last November, owing the lender $550,000. After extensive wrangling, during which his family stayed in the house, he bought it again in March for $280,000, a price he can afford.

On the night after he closed, he joined other members of City Life/Vida Urbana at a foreclosed four-unit building in Dorchester from which most of the tenants had been evicted. A group of artists projected videos on sheets in the windows, showing silhouettes of families re-enacting their last 72 hours before eviction. Garbage filled one of the units. Mr. Velasquez said it hurt to stand amid such loss, but he was jubilant at his own perseverance.

“We’ve been fighting for so long,” he said, “and we win, because we’re still in the house.”

Tax Impact of Principal Reduction

With the Obama administration and private lenders actively considering mortgage-principal-reduction programs to help financially distressed homeowners, the Internal Revenue Service has issued an advisory to taxpayers who receive — or seek to receive — such assistance if it’s offered.

Editor’s Note: The only thing I would add to this, for the moment, is that any principal reduction is basically an admission that your property is not worth the amount of the mortgage. If you have made demand for damages or relief based upon appraisal fraud or other causes of action in or out of court, the taxpayer can take the position that the debt reduction is also in lieu of payment of damages which often is not taxable. Under this theory — which may or may not apply — you would NOT be limited to your principal residence to claim an exemption. Consulting with a licensed attorney or accountant familiar both with federal and state tax law would be strongly advisable.

The reason I mention state law is that the reduction of principal might be the basis for contesting the assessed valuation of your home for real estate taxes, property insurance etc.

IRS tells homeowners how to get tax relief if a lender forgives part of their debt

Reduction of mortgage principal, usually considered taxable income, is expected to become more prevalent as the Obama administration and banks seek ways to prevent foreclosures.

By Kenneth R. Harney

March 14, 2010

Reporting from Washington

With the Obama administration and private lenders actively considering mortgage-principal-reduction programs to help financially distressed homeowners, the Internal Revenue Service has issued an advisory to taxpayers who receive — or seek to receive — such assistance if it’s offered.

The IRS gets involved in mortgage principal write-downs because the federal tax code generally treats any forgiveness of debt by a creditor in excess of $600 as ordinary taxable income to the recipient.

However, under legislation that took effect in 2007, certain home mortgage debt cancellations — such as through loan modifications, short sales or foreclosures — may be exempted from tax treatment as income.

Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corp., recently confirmed that her agency was working on a new program to expand the use of principal mortgage reductions to keep underwater borrowers out of foreclosure.

Most major banks and mortgage companies have preferred monthly payment reductions and other loan modification techniques over cuts of principal balances, but a handful have made limited use of the concept.

One of the largest servicers of subprime home loans, Ocwen Financial Services of West Palm Beach, Fla., has strongly advocated principal reductions to keep people out of foreclosure, and claimed broad success with them. Ocwen President Ron Faris testified to a congressional subcommittee this month that borrowers with negative equity were as much as twice as likely to re-default after a standard payment-reduction loan modification than those who receive partial forgiveness on their principal debt.

But what are the tax implications when your lender essentially says: OK, we recognize that you’re underwater, maybe you’re thinking about walking away, and we’re going to write off some of what you owe to keep you in the house?

IRS guidance issued March 4 spelled out step by step how financially troubled and underwater borrowers can qualify for tax relief when a lender agrees to lower their debt. Here are the basics, should you be considering a short sale or loan modification involving principal reduction.

First, be aware that the federal tax exclusion only applies to mortgage balances on your principal residence — your main home — and not on second homes, rental real estate or business property. The maximum amount of forgiven debt eligible under the law is $2 million for married taxpayers filing jointly and $1 million for single filers.

But there are some potential snares: Your debt reduction can only be for loan amounts that you’ve used to “buy, build or substantially improve your principal residence.” This includes refinancings that increased your total mortgage debt attributable to renovations and capital improvements of your house. But if you used the proceeds for other personal purposes, such as to pay off credit card bills, buy cars or invest in stocks, the mortgage debt attributable to those expenditures is not eligible for tax exclusion.

When your lender forgives all or part of your mortgage balance, the lender is required by law to issue you an IRS Form 1099-C, a “Cancellation of Debt” notice, which is also sent to the IRS. The form shows not only the amount of debt discharged but the estimated fair market value of the house securing the debt as well.

A few other noteworthy features of the IRS rules: If you’ve been foreclosed upon or you do a short sale and lose money in the process, don’t claim a tax loss on your federal filing. The IRS will turn you down. However, if you go to foreclosure and your lender agrees to cancel all or part of the unpaid mortgage balance as part of the deal, then you can file for an exemption from the IRS.

What if your lender reduces the debt on your house but you continue to own the property and live in it? There’s a tax wrinkle in the fine print: The IRS will require you to reduce your “basis” in the house — your “cost” for tax purposes — by the amount of the forgiven debt. But that’s not likely to be a big concern for most homeowners digging their way out.

Finally, if you want to claim the debt-forgiveness exemption, download IRS Form 982 at and attach it to your return for the year in which the debt was forgiven. And don’t assume that this tax code benefit to homeowners will be around forever. It expires at the end of 2012.

Distributed by the Washington Post Writers Group

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