If your car or other property is repossessed, you may still owe the lender money on the contract. The amount you owe is called the deficiency or deficiency balance. (You can learn all about repossessions in our Repossession of Cars & Property area.)
What Is a Deficiency Balance?
When your lender has your car or other property repossessed, it sells the property, usually at auction. If the proceeds from the sale don’t cover the total of what you owe to the lender (they rarely do) you may be liable for the balance, called a deficiency or a deficiency balance.
The Repossession Sale
Although laws differ among states, generally, the lender must send you a notice that the property will be sold and must give the date, time, and location of the sale. The notice must also tell you whether you are liable for any deficiency and must provide a phone number where you can find out how much you still owe. You are entitled to attend the sale and bid. There are two kinds of sales: a public sale, which is open to anyone; or a private sale, to which the lender invites only certain people who it feels might be interested. A private sale can only be held if the item “is of a type customarily sold in a recognized market” or “is the subject of widely distributed standard price quotations.” Cars are frequently sold at private sales to which used car dealers and others who regularly buy repossessed cars are invited. If the notice doesn’t give you the date and location of the sale, call the lender and find out.
The Sale Must Be Commercially Reasonable
The law requires that the lender conduct every aspect of the disposition of the vehicle in a "commercially reasonable" manner, but that may be interpreted differently in different courts. In fact, repossession sales are often attended only by used car dealers, who have a motive to keep the bids very low. This is one reason why most property sold at repossession sales brings in far less than the lender is owed. For instance, a car valued at $12,000 might sell for $5,000, and a refrigerator worth $800 might sell for $250. And even though you could have sold the item for much more, the sale usually will be considered “commercially reasonable.” If you attend, you can bid (if you have the cash), but the dealers are apt to outbid you.
The Deficiency Balance After Sale
After the item is sold, the sale price is subtracted from what you owe the lender. Then, the cost of repossessing, storing, and selling the property is added to the difference. Very often, you are liable for that balance: the deficiency balance.
Avoiding a Deficiency Balance
Here’s one suggestion for avoiding a deficiency balance: If your property, especially a motor vehicle, is about to be repossessed, ask for a contract reinstatement just to get the vehicle back so you can sell it yourself. Even if you get $7,000 for a $9,000 car, it’s better than the lender repossessing it and selling it for $3,000. You can use the $7,000 to pay off your lender and will owe only $2,000 more, far less than the $6,000 you’d owe if the lender sold it through repossession.
Some lenders will forgive or write off the deficiency balance if you clearly have no assets. Where the amount forgiven is $600 or more, the lender will issue you a Form 1099-C or 1099-A, and the IRS will expect you to report the forgiven balance as income on your tax return.
How the Lender Collects the Deficiency
If the lender doesn’t forgive or write off the balance, expect dunning letters and phone calls, probably from a collection agency.
Restrictions on Deficiency Balances
In about half of the states you won’t be liable for a deficiency balance on certain kinds of transactions or if the amount still owing or that you originally paid is less than a few thousand dollars. The rest of the states do not place any limits on deficiency balances after repossession. To find out if your state prohibits collection of deficiencies in certain situations, see State Limits on the Collection of Deficiency Balances.
If a lender sues you instead of repossessing the property, you are not likely to be liable for any deficiency.
Defenses Against the Collection of a Deficiency Balance
It is common for creditors to make mistakes in the repossession process. Most states bar creditors from collecting a deficiency balance if they fail to comply with notice requirements (such as notifying you of the right to cure or of the sale) or didn’t sell the property in a commercially reasonable manner. If you think the creditor made a mistake, you must raise this defense at the time you are sued for the deficiency balance. Because these cases can be complex, it’s a good idea to consult a lawyer. (To find a lawyer near you, visit Nolo’s Lawyer Directory.)
Suing the Lender
If you’d rather take the offensive, you can sue the lender for wrongful repossession. For large items, such as cars, you’ll probably need a lawyer. But for smaller items, you can probably represent yourself in small claims court. (To learn how, see our Small Claims Court section.)
Filing for Bankruptcy
If you've become overwhelmed with debt in addition to dealing with a deficiency, you may find relief through bankruptcy. The automatic stay will stop collection efforts, and the discharge will likely free you from much of your debts including a deficiency. Learn more about what bankruptcy can do.