You probably already know what a deficiency judgment is. Generally, it’s a lawsuit to collect unpaid debts, and in our business, it’s a lawsuit to collect the balance due on a mortgage after a foreclosure. Not all states allow lenders to do this, but many of them do.
When you have to sell your home through foreclosure or short sale, is there any way to prevent a deficiency judgment from being awarded? What happens in those situations?
The only way to avoid a deficiency judgment before it happens is to negotiate with the bank about the terms of a short sale. In these cases, the bank has a choice whether to maintain the property at their expense or allow the home to be sold at less than its value. When they know that the homeowner doesn’t have the resources to pay the debt anyway, occasionally the bank will cut their losses, approve the short sale, and forego the collections process.
When the lender won’t agree to waive their right to collect that leftover debt, they ask the court to grant them a deficiency judgment against the homeowner. Afterward, only paying off the debt or having it discharged in bankruptcy will make it disappear.
What will be the amount of the deficiency judgment? In the case of a foreclosure, the judge will take the balance due on the mortgage and subtract the greater of the high bid at the auction or the appraised value of the home. When the house is sold in a short sale, the amount the bank received from the sale is subtracted from the mortgage balance.
Either way, the court will order the homeowner to repay that amount to the lender. If more than one lienholder on the home chose to file a similar lawsuit, the homeowner may end up with more than one deficiency judgment.
One of the first things that usually happens after a deficiency judgment is issued is that it begins earning interest. By this time, the dollar amount has already gone up if the bank has any REO expenses, so adding interest only blows up the amount due. In Florida, deficiency judgments rack up 11 percent per year. What’s the interest rate in your state?
After establishing the new debt from the deficiency judgment, a bank typically turns around and sells the debt for pennies on the dollar. Banks know that collecting money from someone who couldn’t pay their mortgage is not worth their time and expense. They prefer to cut their losses and unload the debt on someone else.
Besides the deficiency judgment, the former homeowner also has a wounded credit report and a lower FICO score. Having a foreclosure on record is one thing, but a deficiency judgment or a low FICO score could influence a critical decision by others on whether to give that person a job, a loan, or a rental home.
The foreclosure scenario is changing. There are more property foreclosures than ever right now, and that means deficiency judgments could be increasing as well. The government is taking the lead in re-evaluating how foreclosures are handled. We may see some changes in the way deficiency judgments are handled in the near future, and we may not.
For now, your best strategy is to try and get the lender to see the wisdom of forgiving the debt and reporting the mortgage as “paid in full as agreed” on your credit report. Negotiating that deficiency judgment away is the key to survival here, because it can hang over your head for a long time.
Need to learn more about foreclosures? Visit the Strategic Real Estate Coach website. You’ll be able to register for weekly updates on the latest developments in the mortgage industry and more!
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