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If the foreclosed property is sold for less than the remaining primary mortgage balance, and there is no insurance to cover the loss, the court overseeing the foreclosure process may enter a deficiency judgment against the borrower. Deficiency judgments can be used to place a lien on the borrower’s other personal property, obligating the borrower to repay the difference or suffer the loss of one’s property. It gives the lender a legal right to collect the remainder of debt out of the borrower’s other existing assets.
However, there are exceptions to this rule. If the mortgage is classified as “non-recourse debt,” then in the event of foreclosure the borrower has no personal liability. This is often the case with residential mortgages. If so, the lender may not go after the borrower’s personal assets to recoup additional loss.
The lender’s ability to pursue a deficiency judgment is based on state law. Some states have what is known as ‘recourse’ loans, other states have ‘non-recourse’ loans and some have a combination. It is critical for every homeowner who lost their home, either through a short sale or foreclosure, to contact a real estate attorney and get advice regarding their own personal situation and to determine if their former lender can get a deficiency judgment against them. State statutes do vary, and will govern:
- Whether a second/junior lender can obtain a deficiency judgment as a part of the foreclosure process, or whether separate legal action against you is required to obtain payment of the second mortgage
- The compliance procedures required of a second mortgage lender in seeking a deficiency judgment-some state statutes mandate strict compliance in obtaining a deficiency judgment
Recourse loans get their name from the fact that lenders have power. They are allowed to go after you for amounts that you owe - even after they’ve taken the collateral you used to secure the debt (for a homeowner this would be the house the bank took back when they foreclosed). In a state that has ‘recourse loans’, a lender can ask the court overseeing the foreclosure to enter a deficiency judgment against the homeowner for an amount reflecting the difference between the mortgage balance and what the foreclosed property sold for
A lender can obtain a judgment for the entire amount of the unpaid debt or a deficiency judgment on the difference between what it is owed and what it collects. For example, if a lender is owed $250,000 but collects $100,000, the lender can ask the court for a deficiency judgment in the amount of $150,000. If a lender gets a deficiency judgment, the lender can go after personal assets, garnish wages, place a lien on a bank account, seize tax returns or place a lien on personal, business, and real estate assets.
In some states a deficiency judgment can stay valid for as long as 20 years. A lender may sell the deficiency to a third party debt collector.
Just because a lender can get a deficiency judgment against a homeowner doesn’t mean they always decide to pursue one. A lender will consider the likelihood of success in collecting on a deficiency judgment, weighing it against factors such as the added time and expenses in obtaining the judgment, including legal expenses and appraisal fees. If the home was lost due to a short sale, most lenders will look at the financial information that was submitted by the homeowner at the time and look at the assets listed. If the lender feels there are sufficient assets to go after and they believe they can be successful in recovering some of their losses, they are more likely to ask the court to enter a deficiency judgment.
A ‘non-recourse’ loan does not allow the lender to pursue anything other than collateral. For example, if you default on your ‘non-recourse’ home loan, the bank can only foreclose on the home as the home was the collateral that secured the mortgage. They generally cannot take further legal actions against you. The bank is out of luck even if the amount from the short sale or foreclosure do not repay the loan.
In most states, original mortgages (the ones taken out at the time of purchase and known as ‘purchase money mortgages’) are typically ‘non-recourse loans’; however, refinanced loans and home equity lines of credit are usually ‘recourse loans’. Any other loans taken out against the property being foreclosed (second mortgages, home equity lines of credit) are “wiped out” by foreclosure (in the sense that they are no longer attached to the property), but the borrower is still obligated to pay them off if they are not paid out of the foreclosure auction’s proceeds.
If the lender chooses not to pursue deficiency judgment-or can’t, because the mortgage is ‘non-recourse’-and writes off the loss, the borrower may still have to pay income taxes on the un-repaid amount even if it can be considered “forgiven debt.” See the article Mortgage Forgiveness Debt Relief Act of 2007.
Important Note:
Under the new HAFA program, participating lenders must fully release borrowers from future liability for the first mortgage debt and, if the subordinate lien holders receive an incentive under HAFA, those debts must be released as well (no cash contribution, promissory note or deficiency judgmentis allowed).
Many states have recently enacted anti-deficiency laws to protect the growing number of American homeowners who are losing their homes either through a short sale or foreclosure.
NC Law
NC is a recourse state. Under NC law, the lender may release the lien but still hold the seller liable for the deficiency, meaning the remaining amount due on the loan. Sellers in short sales should be aware that they may be responsible for the deficiency, even if the bank approves the sale of the home. It is up to the each lender to determine if they will charge the seller with a deficiency judgment or not. In some cases, the lender will accept the short sale, release the lien and consider it full and final settlement of the debt. Other lenders will accept the short sale, release the lien but refuse to consider it a full and final settlement of the debt. In these cases, the lender will assign a deficiency judgment to the sellers. Whether or not the lender will consider the debt as paid in full is usually stated in the approval letter that the seller will get from the bank indicating the bank’s approval of the sale.
What is an SFR?
The complex details involved with short sales and foreclosures are unique calls for specialized expertise. Contact an agent such as myself that has earned the Short Sale and Foreclosure Resource (SFR) Certification through the National Association of Realtors and who is committed to guiding you through the process, setting realistic expectations, and helping you make the right decision to avoid foreclosure.
If you are in a situation where your home is “underwater” due to falling home prices, you are unable to make your current mortgage payments and you are considering pursuing options such as a short sale, deed in lieu of foreclosure, strategic default or even foreclosure, there could be drawbacks that I, as a real estate agent, cannot advise you on. For your protection, I suggest that all homeowners:
- Obtain legal advice from a competent real estate lawyer regarding deficiency judgments
- Call an accountant or CPA to discuss short sale and foreclosure tax ramifications
Except for certain conditions pursuant to the Mortgage Forgiveness Debt Relief Act of 2007, be aware the I.R.S. could consider debt forgiveness as income, and there is no guarantee that a lender who accepts a short sale or foreclosure will not legally pursue a borrower for the difference between the amount owed and the amount paid. In some states, this amount is known as a deficiency. A lawyer can determine whether your loan qualifies for a deficiency judgment or claim.
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