1099-C snarls mortgage qualifying

Incomplete tax form, old charged-off debt may alter how underwriters view you

To Her Credit columnist Sally Herigstad
Sally Herigstad is a certified public accountant and the author of "Help! I Can't Pay My Bills: Surviving a Financial Crisis" (St. Martin's Press, 2006). She writes "To Her Credit," a weekly reader Q&A column about issues involving women, credit and debt, for CreditCards.com, and also wrote for MSN Money, Interest.com and Bankrate.com, and has guested on Martha Stewart Radio and other programs.

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Dear To Her Credit,
I received a Form 1099-C from Chase, but they did not enter an Identifiable Event Code. Is it required? Also, this charge-off is on my credit report. My fiance and I are trying to get a home loan, we need two loans. We are approved for the first loan. The second loan is a home equity loan, which they denied. They said five years needs to pass before we'll qualify for a home equity loan. Is this true everywhere? We live in California. -- Zoila


Dear Zoila,
The Internal Revenue Service instructions for Form 1099-C -- the form creditors send to report canceled debt -- tell the financial institution to enter a code for the "identifiable event" used to determine whether a debt is no longer collectible or being collected.

If Chase did not enter a code on your Form 1099-C, it may have been the result of an oversight or mistake. Call Chase to find out. Odds are the missing code does not change the fact that you have income from a canceled debt or that you need to report it on your income tax return.

That doesn't necessarily mean you'll have to pay tax on the canceled debt. The IRS has a list of exceptions to paying tax on forgiven debt, the most expansive exception being that you were insolvent at the time the debt was canceled. That means you had more debts than assets, which made paying your bills impossible.

I don't know if your lender has a strict policy against home equity loans within five years of a credit card balance charge-off. It's possible, but it's more likely that the charge-offs are lowering your credit score to the point where you are not qualifying for the loan. If your score is under 500, you'll have a difficult time getting a home equity loan. To get the best interest rate and terms on a home equity loan, you need a score somewhere around 700 or above.

You may have qualified for a mortgage with a lower credit score, because that mortgage is first in line to be secured by the value of your home. In addition, your home loan may be guaranteed by the federal government; for example, if you got an FHA insured loan. The lender isn't taking much of a chance on you in that case.

When people get a second mortgage or home equity line of credit at the same time they purchase a home, it's often because they don't have enough cash for the required down payment. If that's the case, you have a few options at this point:

  • Try applying at a different financial institution. Regardless of what they may have told you, loan underwriting policies do vary from lender to lender.
  • Come up with the cash some other way. Sell a car or boat, for example, or borrow from a relative. You may even want to take some money from a retirement account, but only if it doesn't jeopardize your retirement planning and you think that the financial benefits of buying a home now outweigh the disadvantages of taking some money from your retirement plans. You should be aware of the penalty and other tax consequences before you go this route. You can withdraw up to $10,000 from an IRA, SEP, SIMPLE IRA or SARSEP plan to make a qualified first-time home purchase without paying a penalty, according to the IRS. This exception does not apply to withdrawals from 401(k) and similar plans.
  • Wait until you have more money saved up, and your debt charge offs are further in the distant past. As you continue to pay your bills on time, you may be surprised how quickly your score improves. And if you and your fiancé work hard to save for a house together, you may not need to borrow as much as you thought. Don't wait too long, however. In many parts of the country, housing prices are going back up at a rapid rate.

See related: 1099-C frequently asked questions

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Updated: 03-23-2019