In foreclosure law, it's important to know if your mortgage loan is a recourse loan or a nonrecourse loan. Usually, whether your mortgage is recourse or nonrecourse depends on your state law. For recourse loans, the lender can obtain a deficiency after foreclosure. For nonrecourse loans, the lender cannot obtain a deficiency.
(Learn more about the foreclosure process in our Foreclosure topic area.)
With a recourse loan, the borrower is personally liable for the debt. With respect to foreclosure, a debt is considered to be recourse if the lender is able to obtain a deficiency judgment.
What Is a Deficiency After Foreclosure?
When a lender forecloses on a mortgage, the total debt owed by the borrower to the lender frequently exceeds the foreclosure sale price. The difference between the sale price and the total debt is called a “deficiency.”
Example. Say the total debt owed is $200,000, but the home only sells for $150,000 at the foreclosure sale. The deficiency is $50,000.
A deficiency judgment is a personal judgment that the lender obtains against the debtor to recover the deficiency. Generally, once the lender gets a deficiency judgment, it may collect this amount (in our example, $50,000) from the borrower by doing such things as garnishing the borrowers’ wages or levying the borrowers’ bank account. (Learn about methods that creditors can use to collect judgments.)
(To learn more about deficiency judgments in the foreclosure context, see our Deficiency Judgments After Foreclosure area.)
With a nonrecourse mortgage loan, the lender cannot do anything other than foreclose on the property. The lender may not obtain a deficiency judgment even if the sale proceeds do not repay the total debt owed on the loan.
Recourse or Nonrecourse Varies from State to State
Whether a mortgage loan is recourse or nonrecourse varies from state to state, depending on the state's laws.
Most states allow a lender to obtain a deficiency judgment, but typically there are restrictions. For example, usually the deficiency is limited by the fair market value of the property.
Example: If the total debt is $200,000 and lender bids $150,000 at the foreclosure sale and purchases the property, the deficiency is $50,000. Generally, this means the lender could file a subsequent action where it would be granted a deficiency judgment for $50,000 and be able to collect that amount from the borrower. However, if the fair market value of the property is really $175,000, the lender could only obtain a deficiency judgment in the amount of $25,000.
Since the lender is typically the only bidder at the foreclosure sale, the fair market value limitation prevents a lender from making an extremely low bid in order to collect a big deficiency judgment.
Also, some states (such as Arizona, California, and Oregon) prohibit deficiency judgments on most residential properties or on purchase money mortgages. In other states, like Iowa and Montana, the process for obtaining a deficiency judgment is so burdensome or time-consuming that most lenders opt to forgo pursuing one.
Once a Deficiency Judgment is Obtained
If your state allows deficiency judgments, the only way to escape liability once the judgment is obtained is to file bankruptcy. In Chapter 7 bankruptcy you can discharge the deficiency relieving you of the debt. In Chapter 13 bankruptcy, you usually must pay a portion of the owed amount (it's often a very small portion).
(To learn more about filing a Chapter 7 or Chapter 13 bankruptcy, see our bankruptcy area.)