Sometimes, when a foreclosure sale results in a deficiency, state law allows the bank to get a deficiency judgment—a personal judgment—against the foreclosed homeowner for the amount of the deficiency.
But what if you complete a short sale? In most cases, California law prevents the bank from getting a deficiency judgment after a short sale.
Before you can understand California's law on deficiency judgments and short sales, you need to know the difference between a deficiency and a deficiency judgment.
What's a deficiency? In the mortgage industry, a “deficiency” is:
What's a deficiency judgment? A “deficiency judgment” is a court order against the borrower for the amount of the deficiency. After getting a deficiency judgment, the bank can enforce the judgment through all the various collection procedures, like placing liens on real property, levying bank accounts, or garnishing wages.
California law prohibits a deficiency judgment following the short sale of a residential property with no more than four units. Junior lienholders are also prohibited from pursuing a deficiency judgment if they agree to the short sale. (Cal. Code Civ. Proc. § 580e).
Though if you perpetrate fraud or commit waste with respect to the property (damage it), the bank can seek damages against you. Also, the anti-deficiency law doesn’t apply to a borrower that is a corporation, LLC, limited partnership, or political subdivision of the state.
If the bank agrees to waive the deficiency as part of a short sale (or deed in lieu of foreclosure) and issues you an IRS Form 1099-C (“Cancellation of Debt” form), you might have to include the canceled amount as income for tax purposes, depending on the circumstances.
Though, an exception or exclusion, like if the loan is nonrecourse, might save you from having to report canceled debt as part of your income. (To learn more, see Canceled Debt: What Happens at Tax Time? For specific information about your particular situation, talk to a tax attorney or qualified tax professional.)
If you want to fight a foreclosure in court or need help arranging a short sale or deed in lieu of foreclosure, consider talking to a lawyer. A HUD-approved housing counselor can also provide you with information about different options to avoid a foreclosure.