Deficiency Balances After Repossession

After you default on your car loan and the lender repossesses the vehicle, the lender will usually sell the car, either through a private sale or at a public auction, to recoup what you owe. In many cases, the sale proceeds aren't enough to cover the remaining balance on the loan, plus the lender's costs in repossessing the car. If that happens, you'll owe the difference, called the "deficiency" or "deficiency balance."

In most states, the lender can try to collect the deficiency from you. Some states restrict the lender's ability to collect a deficiency under certain circumstances. Those circumstances rarely apply in car repossession cases, though. If you don't pay, the lender can sue you. If you don't have a defense to the deficiency, the lender will get a judgment against you. Once the lender has a judgment, in most cases, it can use various methods to collect it, including garnishing your wages or taking funds from your bank account.

You have several options for dealing with a deficiency, even if you don't have any defenses to it. You can pay the deficiency in full, make payment arrangements with the lender to pay the debt over time, or negotiate a settlement. In some cases, it might be best to do nothing; in others, you might want to consider bankruptcy.

What Is a Deficiency Balance on a Car Loan?

Again, when your lender repossesses your car or other property, 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 might be liable for the balance, the "deficiency."

Example. Say you owe $12,000 on an auto loan before defaulting on the payments. The lender repossesses the car and sells it at auction for $3,500. The lender incurs repossession and auction fees of $150. You would owe a deficiency of $8,350 ($12,000 - $3,500 - $150 = $8,350).

How Car Repossession Sales Work

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're liable for any deficiency and provide a phone number to find out how much you still owe. You can attend the sale and bid.

Public Sales vs. Private Sales

The sale might be public, open to anyone, or private, where the lender invites only certain people 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. Car dealers and others who regularly buy repossessed cars are typically invited to the sale. 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 courts may interpret that phrase differently. In fact, repossession sales are often attended only by used car dealers, who have a motive to keep the bids very low. So, 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 likely to outbid you.

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're liable for that balance: the deficiency balance.

How Do I Not Pay a Deficiency?

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 unless you qualify for an exception or an exclusion.

What Is Deficiency Collection?

If the lender doesn't forgive or write off the balance, expect dunning letters (collection letters) and phone calls, probably from a debt 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 don't place limits on deficiency balances after repossession.

Defenses Against the Collection of a Deficiency Balance

It's 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're sued for the deficiency balance. Because these cases can be complex, it's a good idea to consult a lawyer.

Suing the Lender

If you'd rather take the offensive, you can sue the lender for wrongful repossession. For large items, like cars, you'll probably need a lawyer. But for smaller items, you can probably represent yourself in small claims court.

Options If You Owe a Deficiency

Generally, you have the following options if you don't have any defenses to the deficiency.

Pay the Deficiency

If you owe a deficiency and have resources available, you can simply pay the full amount you owe. This option is potentially a good course of action when the deficiency is relatively small and you have access to enough money to cover the balance.

Sometimes, getting a low-interest loan from a bank, credit union, friend, or family member makes sense. This option allows you to pay the lender in full now to avoid stressful collection activity and added interest charges.

Make Payment Arrangements With the Lender

Many lenders are willing to set up a reasonable payment plan to allow you to pay off the deficiency balance over time. The lender might require you to set up automatic payments from your bank to ensure you make your scheduled payments.

Some lenders will ask you to sign a legal agreement in which you agree to pay the full amount of the deficiency according to the agreed-upon payment plan.

Can You Negotiate a Deficiency Balance?

Many lenders will settle the deficiency debt for a percentage of your debt. Some lenders will ask for proof of financial hardship before agreeing to settle. You might be able to show financial hardship if you're unemployed, laid off, or disabled, or by providing a tax return or pay stubs and a list of living expenses to show the lender why you can't pay the debt in full. The settlement will likely need to be made in a lump sum, and many lenders will expect payment within ten days to two weeks.

The disadvantage to this option is that you'll have to come up with a lump sum of money. But the benefit is that you might be able to eliminate around 20% to 75% of the debt, on average. Also, keep in mind that you might have potential tax consequences if the lender agrees to forgive a portion of the debt you owe.

When You Can't Pay

If none of the above options is a valid option for you, doing nothing might be your best choice. While your lender could be entitled to collect the deficiency from you, it might not attempt to do so for some time, if ever. You might want to wait until the lender starts actively pursuing the debt before you decide on a repayment option.

If your lender is actively trying to collect the debt, but you're judgment-proof, meaning you have little or no income or assets that your lender can take, you might not need to take any action at all.

Filing for Bankruptcy

Finally, if the deficiency isn't the only debt troubling you, filing for bankruptcy might be a good option. You might be able to discharge a deficiency after a vehicle repossession along with your other unsecured debts.

If you've become overwhelmed with debt in addition to dealing with a deficiency, you might find relief through bankruptcy. The automatic stay will stop collection efforts, and a discharge could free you from much of your debts, including the deficiency.

Talk to an Attorney

If you need help dealing with how to repay a deficiency or raising a defense to a deficiency lawsuit, consider talking to a debt settlement lawyer. If you're considering filing for bankruptcy, consult a bankruptcy attorney.