When deciding whether to fight a foreclosure, take steps to avoid it, or just walk away, you’ll want to know whether you’ll be stuck for the money that the lender loses because of your default. This is usually measured as the difference between what the lender ends up with at the end of the day and the amount of your loan. It’s called a deficiency, and it can be many thousands of dollars. Here's an example:
Jonas owes $350,000 on a house he bought for $400,000 but that is now worth $300,000, according to a recent appraisal. He is no longer able to earn overtime at his job and falls behind on his payments. The lender threatens foreclosure and will not cooperate with Jonas in working something out. Not wanting to fight the foreclosure or file for bankruptcy, Jonas hands the keys to the lender and walks away.
The lender forecloses on the property and schedules it for auction at a minimum bid of $300,000. No bids are made, so the lender keeps the property. In Jonas’s state, the lender can sue for the difference between the property’s value and the amount owed on the loan—in this case, $50,000. Unless Jonas files for bankruptcy to wipe out this debt, the lender (or more likely, a collection firm) will go after his paycheck and bank account.
Depending on where you live, you may not have to worry about a deficiency judgment. A few states prohibit lenders from suing for deficiencies stemming from mortgages on a borrower's principal residence. (Loans that fit in this category are called non-recourse loans because the lender has no recourse if you default.)
In almost every nonjudicial foreclosure state, the lender cannot recover a deficiency without bringing a separate lawsuit and getting a money judgment. This usually means that the lender won’t pursue the deficiency because of the expense. In a judicial foreclosure, on the other hand, most states allow the lender to seek a deficiency judgment as part of the underlying foreclosure lawsuit, but a few states require a separate lawsuit.
Many states limit the amount of the deficiency to the difference between the loan and the property’s fair market value. For instance, if the loan is for $400,000, the fair market value is $350,000, and the property is sold for $300,000, the deficiency judgment is limited to $50,000. This is so even though the lender technically lost $100,000—the difference between the loan amount and the sales price. Fair market value typically is determined by a fairly complex statutory appraisal process set out in state statutes.
You can wipe out a deficiency judgment by filing for Chapter 7 or Chapter 13 bankruptcy. Check our Summary of State Foreclosure Laws to find your state’s rules on deficiency judgments.