Most states have laws that allow a lender to go after a borrower for a deficiency—that is, the amount that the foreclosure sale proceeds fall short of the total mortgage debt—following a foreclosure. But many of these states protect homeowners from liability for deficiencies under certain circumstances, like if the loan money was used to buy property that's used as an owner-occupied dwelling or after a nonjudicial foreclosure. Also, even if your state allows deficiency judgments, you might be able to eliminate or reduce the deficiency amount in some cases.
If you stop making your mortgage payments—or breach the loan contract in some other way—the lender will most likely foreclose. As part of a foreclosure process, the property is sold to pay the lender back. When the total debt the borrower owes is more than the foreclosure sale price, the difference between the debt and the sale price is called a deficiency.
Example. Suppose you owed $300,000 on your mortgage, your home sold for $250,000 at a foreclosure sale, and the lender incurred $5,000 in foreclosure costs and fees. The deficiency is $60,000 ($300,000 - $250,000 + $10,000 = $60,000).
In some states, the lender can seek a personal judgment (called a deficiency judgment) against the borrower to recover the deficiency. Generally, once the lender gets a deficiency judgment, the lender may collect this amount—in our example, $60,000—from the borrower by typical collection techniques, like telling your employer to deduct money from your paycheck (a wage garnishment) or forcing your bank to take money out of your account (bank levy).
If you live in a state that allows for a deficiency judgment after a foreclosure, you can probably eliminate your liability for the judgment by filing for Chapter 7 or Chapter 13 bankruptcy.
Chapter 7 bankruptcy. In most Chapter 7 bankruptcies, a lender’s deficiency judgment is treated as an unsecured debt, like credit card obligations or medical bills. This means that when you get a discharge, the lender can no longer come after you to collect the debt.
Chapter 13 Bankruptcy. Unless the lender places a lien on any of your assets, its deficiency judgment is an unsecured debt in a Chapter 13 bankruptcy. The lender will likely receive little or nothing through the Chapter 13 repayment plan. When you finish making all of your plan payments, the deficiency judgment is discharged along with your other dischargeable debts.
Often, in order to get a deficiency judgment, a lender must file a separate lawsuit against the borrower after the foreclosure. In some cases, you might be able to challenge the lender’s right to a deficiency judgment or the amount of the deficiency judgment in this lawsuit. For example, if the lender used robosigned documents to foreclose or didn’t pay fair market value at the foreclosure sale, you could have a defense to the deficiency judgment action.
Robosigning. All states require lenders to follow certain procedures when foreclosing. These procedures typically include filing certain documents with the court (judicial foreclosures) or with the county recorder (nonjudicial foreclosures). If the lender used robosigned documents—documents that a representative of the mortgage lender signed without reading or having any personal knowledge about the accuracy of the information in the documents—this can provide a defense to a deficiency judgment action.
While robosigning was widespread during the mortgage foreclosure crisis, it now occurs far less frequently. Still, if you think robosigned documents may have been used in your foreclosure and you’re facing a deficiency judgment, it's worth speaking to an attorney to learn about your options. (Learn more about robosigned documents in foreclosures.)
Fair market value. Many states have a law that limits the amount of the deficiency to the difference between the total mortgage debt and the property’s fair market value, which is normally determined by a fairly complex statutory appraisal process set out in the state statutes. If you live in a state with this type of law and the lender bought the home at the foreclosure sale for less than the fair market value, you may challenge the amount of the deficiency. A court will then likely limit the deficiency judgment to the difference between the total debt and fair market value of the home.
Foreclosure laws and deficiency judgment laws vary from state to state. Also, the defenses mentioned in this article are only a few of the possible defenses available to deficiency judgment or foreclosure, but there are, of course, others. If you’re facing a foreclosure and worried about a deficiency judgment, consider talking to a local foreclosure attorney. A foreclosure attorney can also explain different options that might be available to prevent a foreclosure, like a loan modification, forbearance agreement, or repayment plan. If you can’t afford to hire a lawyer, consider speaking with a HUD-approved housing counselor.
If you’re thinking about filing for bankruptcy, consider talking to a bankruptcy attorney.