Even if you're making the mortgage payment on your home, that doesn't guarantee you can cover your rental property too. High repair expenses, a long stretch standing empty -- all sorts of things can turn a good rental into a money loser. Losing an investment isn't as disastrous as losing your home, as it doesn't leave you homeless. It's still going to hurt, though.
There are two kinds of mortgage loans: recourse and non-recourse. Recourse loans are the worst ones to have after a foreclosure because you're personally liable for any leftover debt. If you have a $200,000 mortgage and the house sells at auction for $150,000, the bank can sue you for the remainder. If your loan is non-recourse, you owe nothing. Your state's laws may determine whether the loan is non-recourse.
Your lender may decide that it's not worth pursuing you for the loan and instead send a 1099-C telling you the debt's been cancelled. Unfortunately, cancelled debt is the same as income in the eyes of the IRS. A forgiven $50,000 debt, for instance, is $50,000 you have to report on your Form 1040. Federal law offers an exemption for forgiven mortgage debt if you lose your personal home. There's no exemption, however, for a rental property.
Once foreclosure starts, it may be months before the bank actually takes the property title. During that time, you're still legally responsible for repairs and dealing with tenant complaints. If you decide it's not worth the cost of keeping up your responsibilities, a tenant might be able to sue you in small claims court. If you know when she signs the lease that foreclosure is looming, she can also sue you for not notifying her.
Just like foreclosure on your home, foreclosure on a rental house says you've defaulted on a very big debt. Payment history makes up 35 percent of your credit score in the FICO credit-scoring system. The first late mortgage payment alone can cost you anywhere from 60 to 100 points, depending on your previous score and your overall finances. Foreclosure, when it comes, is another 50 points. Foreclosure alternatives -- finding a short-sale buyer for the house or turning over the deed -- aren't much better for your credit than foreclosure itself.