A deficiency judgment is something that looms over the head of everyone who has to take a loss on their house, whether by foreclosure or by short sale. This isn’t the law in every state, but in many areas the mortgage lender is allowed to sue for the unpaid debt after the sale of the home – and when they can, they usually will.
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?
Most of the time, the only way you can avoid a deficiency judgment is by negotiating with the lender during the pre-foreclosure process. They know how expensive it is to maintain their REO properties. The lender may consent to waive their right to collect the rest of the debt if they see that it will cost them less money in the long run to allow a short sale and simply let the debt go.
If negotiations fail with the bank about the status of the unpaid debt, the homeowner will be ordered by the court to pay it back. Only bankruptcy or paying it off will cancel the debt at that point.
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.
In either case, the homeowner is ordered by the court to pay back the leftover debt. It is entirely possible to have more than one deficiency judgment if there was more than one mortgage on that home.
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?
Next, the lender usually sells these types of debt to collection companies for 5 to 10 percent of the amount due. Since they know their chances of collecting the debt from a financially drained homeowner are slim to none, lenders would rather get the debt off their books and get what they can out of it.
Payment or no payment, the former homeowner now also has a huge ding on their credit report, as if having a foreclosure on record wasn’t bad enough. That judgment will stay on a credit report for at least seven to ten years, depending on certain circumstances, and it will send a FICO score down. That lower FICO score means that the former homeowner could be turned down for loans, jobs, or even housing because of it.
With the number of foreclosures increasing faster than ever, the number of deficiency judgments are increasing right along with them. As the government re-evaluates how foreclosures are done in various scenarios, they may also reconsider how deficiency judgments are handled as well. On the other hand, they 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 how deficiency judgments can affect your life? Visit the Strategic Real Estate Coach website. You’ll gain access to weekly webinars on current events in the mortgage industry and more!
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