Deficiency Judgments: Will You Still Owe Money After the Foreclosure?

Even after you lose your home to foreclosure, you might still owe money to the lender. 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 lender to get a personal judgment, called a "deficiency judgment," against a borrower for the deficiency amount. A deficiency judgment allows the lender to collect additional money from the borrower.

However, a few states protect homeowners from liability for a deficiency from a mortgage loan used to purchase a residence or in other circumstances. You don't need to worry about a deficiency if any of the following applies:

• Your state's law prohibits deficiency lawsuits.
• The lender agrees not to pursue a deficiency after a short sale or deed in lieu of foreclosure.
• You discharge (wipe out) the deficiency or surviving debt in bankruptcy.

What Is a Deficiency in a Foreclosure?

Again, when the foreclosure sale price doesn't cover the borrower's mortgage debt balance, the difference between the total debt and the sale price is called a "deficiency."

Example of a Mortgage Deficiency

If you default on your mortgage loan, the lender can go through a legal process called "foreclosure" to sell your home to repay the outstanding debt. After the lender fulfills all the legal requirements for foreclosure, the final step in a judicial or nonjudicial foreclosure is the foreclosure sale, where the home is sold to a new owner at a public auction.

The foreclosing lender submits the first bid at the sale, a "credit bid." With a credit bid, the lender gets a credit in the amount of the borrower's debt. Most of the time, the lender makes the highest bid at the sale and becomes the new owner of the property because no one else bids. The lender can bid up to the total amount of the debt, including foreclosure fees and costs, or it might bid less. Lenders regularly bid less than the total amount of a borrower's mortgage debt at foreclosure sales.

Again, the difference between the total debt and a lesser bid is the deficiency. For example, suppose Riley loses his job and can't make the loan payments on his home, and the lender forecloses. At the foreclosure sale, the property sells for $575,000. But Riley owes the lender $600,000. The deficiency in this situation is $25,000.

What Is a Deficiency Judgment in Real Estate?

When a foreclosure sale results in a deficiency balance, some states allow the foreclosing lender to get a personal judgment, a "deficiency judgment," against the borrower for the deficiency amount.

Other states have anti-deficiency laws prohibiting the lender from getting a deficiency judgment against the borrower under particular circumstances, like after a nonjudicial foreclosure. Loans that fit into this category are called "nonrecourse" loans.

How Does a Lender Collect a Deficiency Judgment?

If the lender does get a deficiency judgment, depending on state law, it may typically use standard collection techniques, like garnishing the borrower's wages, levying a bank account, or attaching a lien to property to compel the borrower to pay it.

Example. Suppose Jonas owes $350,000 on a house he bought for $400,000. The lender forecloses, and the home sells at an auction for $300,000. In the state where Jonas lives, the lender 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. This amount is what Jonas must pay. Once the lender gets a deficiency judgment, the lender may use the judgment to go after Jonas' paycheck, perhaps through wage garnishment, or take money from his bank account with a levy.

Deficiency Judgments Are Unsecured Debts

But a deficiency judgment is an unsecured debt, like credit card debt. So, you might be able to discharge the debt in bankruptcy. And many states put restrictions on wage garnishments.

Because unsecured debt is often difficult for lenders to collect, lenders frequently sell deficiency judgments to third-party debt collectors at discounted prices. If the lender sells the deficiency judgment to a debt collector, attempts to collect the debt are usually subject to restrictions under the Fair Debt Collection Practices Act and state debt collection laws.

Or you might have a defense to the deficiency, such as you weren't personally served the summons and complaint and didn't appear in the action (if required) or the home's fair market value was less than the plaintiff says it was at the time of the sale, depending on state law.

What If the Property Sells for More Than the Borrower Owes?

If your home sells for more than you owe at a foreclosure sale, you won't have to pay anything to your lender after a foreclosure. In fact, you might be entitled to the excess proceeds from the foreclosure sale.

What States Allow Deficiency Judgments?

Again, in most states, a lender can get a personal judgment (a deficiency judgment) if a foreclosure sale results in a deficiency amount. Depending on state law, the lender might be able to get the judgment only under certain circumstances, like if it chooses to foreclose judicially or if it files a lawsuit following a nonjudicial foreclosure.

Judicial Foreclosure vs. Nonjudicial Foreclosure

Foreclosures are generally either "judicial" or "nonjudicial." Judicial foreclosures go through the court system. Nonjudicial foreclosures don't go through court. (A court has minimal involvement in nonjudicial foreclosures in a few states.)

The foreclosure process that the lender uses depends on state law and the circumstances.

Judicial Foreclosures. With a judicial foreclosure, the lender goes through the state court system. It gets a judge's approval to foreclose. All states permit judicial foreclosures. However, some states require this process exclusively. For instance, in Florida and Ohio, foreclosures are judicial.

Nonjudicial Foreclosures. In a nonjudicial foreclosure, the lender follows the steps that the state statutes set for foreclosing. Around half the states, including California, Nevada, and Washington, allow nonjudicial foreclosures.

While the exact steps for a nonjudicial foreclosure differ from state to state, the lender might have to:

• send the borrower a notice of default
• record the notice of default in the county records, and
• send a notice of sale.

In some states, the lender sends only a notice of sale or a combined notice of default and sale. In others, the lender publishes a notice in the newspaper and posts it somewhere on the property or someplace public.

Deficiency Judgment Laws Vary From State to State

Deficiency judgment laws vary by state and are often complex. Again, the lender might not be able to get the judgment only under certain circumstances. For example, in California, a foreclosing lender can't get a deficiency judgment against a residential homeowner if the foreclosure is nonjudicial or under some other circumstances.

States often prohibit deficiency judgments after nonjudicial foreclosures. So, while most states allow deficiency judgments in some circumstances, you might not have to worry about one. Say the state you live in doesn't permit a deficiency judgment after a nonjudicial foreclosure, and lenders almost always use this procedure to foreclose in your state. Then, you probably don't need to be concerned about a deficiency judgment.

Also, some lenders don't pursue deficiency judgments even when they have the legal right to get one. Whether your lender will seek a deficiency judgment from you depends on the deficiency amount, your finances and assets, and, to some extent, the lender's policies.

How a Foreclosing Lender Gets a Deficiency Judgment

If a foreclosure is nonjudicial, the foreclosing lender must file a lawsuit following the foreclosure to get a deficiency judgment. On the other hand, with a judicial foreclosure, most states allow the lender to seek a deficiency judgment as part of the underlying foreclosure lawsuit. A few states require a separate lawsuit.

State Law Often Limits the Deficiency Judgment Amount

Many states have a law that limits the deficiency amount to the difference between the debt and the property's fair market value.

Example. Say you owe the lender $350,000, and the fair market value of your home is $300,000. The property sells at a foreclosure sale for $250,000. In this situation, if your state has a law limiting the deficiency amount based on the home's fair market value, the deficiency judgment will be restricted to $50,000—even though the lender technically lost $100,000 (the difference between the amount owed and the sales price).

Fair market value is typically determined by a fairly complex statutory appraisal process set out in the state statutes.

How Long Does a Deficiency Judgment Last?

How long a lender has to collect on a deficiency judgment varies from state to state. In Maryland, for example, the lender has 12 years to collect the judgment. Michigan gives the lender ten years to collect.

And in some states, the lender can ask a court to extend a deficiency judgment. In Maryland, the lender may extend the period for another 12 years. In Michigan, for instance, a deficiency judgment can be extended for an additional ten years after the first ten expire.

What to Do When Facing a Deficiency Judgment

You might be able to protect yourself against a deficiency judgment by selling your home in a short sale, completing a deed in lieu of foreclosure, challenging a deficiency judgment lawsuit, or filing for bankruptcy.

Sell Your Home in a Short Sale

Avoiding a deficiency judgment is the main benefit of a short sale. But while many states have laws prohibiting a deficiency judgment in some circumstances after a foreclosure, not many states prohibit a deficiency judgment after a short sale.

California, for example, has a law forbidding a deficiency judgment after a short sale under certain circumstances. But most states don't have this kind of law. So, you could face a deficiency judgment after a short sale if you're not careful.

To avoid a deficiency judgment after a short sale, the short sale agreement must state that the transaction fully satisfies the debt and that the lender waives its right to the deficiency. If the lender doesn't agree to fully waive the deficiency, you can ask for a reduced deficiency amount. You might be able to work out a repayment agreement with the lender.

If the lender gives up its right to some or all of the deficiency and sends you an IRS Form 1099-C, you might have to include the forgiven debt as income on your tax return and pay taxes on it.

Complete a Deed in Lieu of Foreclosure

With a deed in lieu of foreclosure, the deficiency is the difference between the borrower's total mortgage debt and the home's fair market value. Deed in lieu of foreclosure agreements often release the borrowers from having to repay any deficiency, but not always.

The vast majority of states don't have a law prohibiting deficiency judgments after deeds in lieu. So, the lender might decide to sue you for a deficiency judgment after a deed in lieu of foreclosure, assuming state law doesn't prevent it. If the lender plans on getting a deficiency judgment, the transaction documents usually will say that a balance remains after the transaction and include the deficiency amount.

So, to avoid a deficiency judgment with a deed in lieu of foreclosure, the agreement must clearly say that the transaction fully satisfies the debt. If the deed in lieu of foreclosure agreement doesn't have a clause to this effect, the lender might file a lawsuit to get a deficiency judgment against you. Again, if the lender refuses to waive the deficiency, you can request a reduced amount.

And, like with a short sale, you might have a tax liability if the lender forgives some or all of the debt.

Fight the Deficiency Lawsuit

If the lender has to file a lawsuit—separate from the foreclosure—to get a deficiency judgment, you might be able to challenge the lender's right to a judgment or the deficiency amount. (Keep in mind that the lender might be able to get a deficiency judgment in the foreclosure action.)

For instance, say the lender used robosigned documents in the foreclosure or didn't pay the home's fair market value at the foreclosure sale. Then, you might have a defense to the deficiency judgment action. You might not have to pay any deficiency or be able to offset the amount you have to pay.

File for Bankruptcy

You might be able to wipe out your liability to pay a deficiency judgment by filing for bankruptcy.

It probably doesn't make sense to file for bankruptcy just to discharge a deficiency judgment. But if you're facing foreclosure and think your home will sell for less than you owe, talk to a bankruptcy attorney. A Chapter 7 bankruptcy might take care of any deficiency you owe and wipe out other debts like credit card balances, unpaid medical and utility bills, and personal loans.

What Happens to Second Mortgages, HELOCs, and Other Junior Liens?

Generally, when a senior lienholder forecloses, any junior liens—like second mortgages and HELOCs, among others—are also foreclosed, and those junior lienholders lose their security interest in the real estate. In this situation, junior lienholders are sometimes called "sold-out junior lienholders." But that doesn't mean that you don't still owe money to junior lienholders.

Suppose a junior lienholder, like a second mortgage lender, is sold out in this manner, and the foreclosure sale proceeds weren't sufficient to pay what you owe to that junior lienholder. In that case, the junior lienholder could sue you personally on the loan's promissory note. So, if the equity in your home doesn't cover second and third mortgages, for example, you might face lawsuits from those lenders to collect the balance of those loans.

Talk to a Foreclosure Lawyer

Deficiency judgment laws vary from state to state and can be complicated. If you're facing a foreclosure, it's crucial to understand how the law works in your state.

The bottom line is that whether you'll owe a deficiency after foreclosure depends on your state's foreclosure laws and what kind of foreclosure you're facing. So, to find out whether your state has an anti-deficiency statute and whether you're facing a judicial or a nonjudicial foreclosure, do some legal research or talk to a foreclosure lawyer.