When foreclosure sale proceeds aren't sufficient to repay the full amount of a mortgage loan, the difference between the sale price and the total debt is called a "deficiency." A short sale or deed in lieu of foreclosure might also result in a deficiency.
Many states allow a foreclosing bank to get a personal judgment, called a "deficiency judgment," against a borrower for the amount of the deficiency.
In many states, but not all, a bank can get a deficiency judgment against a borrower for the amount of the deficiency.
Example. Suppose Jonas owes $350,000 on a house he bought for $400,000, but is now worth $300,000, according to a recent appraisal. The bank forecloses on the property and the home sells at an auction for $300,000. In the state where Jonas lives, the bank may file a lawsuit after the foreclosure seeking the difference between the sale price and the amount owed on the loan—in this case, $50,000. Once the bank gets a deficiency judgment, the bank may use the judgment to go after Jonas' paycheck (through a wage garnishment) and bank account (with a bank levy).
In other states, though, you don’t have to worry about a deficiency judgment. Some states prohibit banks from suing for deficiencies under certain circumstances, like after a nonjudicial foreclosure. Loans that fit in this category are sometimes called nonrecourse loans.
Check our Key Aspects of State Foreclosure Law: 50-State Chart to learn more about your state’s laws on deficiency judgments.
If a foreclosure is nonjudicial, the bank has to file a lawsuit following the foreclosure to get a deficiency judgment. In a judicial foreclosure, on the other hand, most states allow the bank to seek a deficiency judgment as part of the underlying foreclosure lawsuit; a few states require a separate lawsuit.
Many states have a law that limits the amount of the deficiency to the difference between the debt and the property’s fair market value. For instance, if your state has this type of law and you owe the bank $400,000, the fair market value of your home is $350,000, and the property sells at a foreclosure sale for $300,000, a deficiency judgment will be limited to $50,000—even though the bank technically lost $100,000 (the difference between the amount owed and the sales price).
Fair market value typically is determined by a fairly complex statutory appraisal process set out in state statutes.
You might be able to wipe out your liability to pay a deficiency judgment by filing for bankruptcy. While it might not make sense to file for bankruptcy just to discharge a deficiency judgment, if you’re considering bankruptcy to deal with multiple debts—like credit card balances, unpaid medical and utility bills, and personal loans—consider talking to a bankruptcy attorney.
Deficiency judgment laws vary from state to state and can be complex. If you’re facing a foreclosure, it’s important to understand how the law works in your state. To find out more, consider talking to a knowledgeable foreclosure lawyer.