For homeowners having trouble making their monthly mortgage payments, a short sale might sound like the perfect solution to avoid foreclosure. In a short sale, the homeowner sells the home for less than the mortgage debt balance. The lender agrees to accept the sale proceeds and release the lien on the property. The proceeds of the sale pay off a portion of the mortgage balance. If you're considering this route, you should be aware that you might still be on the hook for any amount that exceeds the short sale price, called a "deficiency."
In some states, the lender can seek a personal judgment against the borrower to recover the deficiency. Generally, once a "deficiency judgment," a personal judgment for the deficiency, has been obtained, the lender may collect this amount from the borrower using regular collection methods, including garnishing wages or levying a bank account.
Most states allow lenders to obtain a deficiency judgment following a short sale, but a couple of states prohibit it.
In most states, the lender can go after the homeowner for a deficiency judgment following a short sale. But a couple of states, like California and Nevada, have laws that prohibit deficiency judgments following a short sale under certain circumstances.
If you live in a state that doesn't have a law that prohibits a deficiency judgment following a short sale, you can avoid one by getting the lender to waive the deficiency. The short sale agreement must expressly state that the lender waives its right to the deficiency and that the transaction is in full satisfaction of the debt. Without this waiver, the lender might later file a lawsuit against you to obtain a deficiency judgment after the short sale is completed.
If the lender does eventually get a deficiency judgment, you might be able to eliminate your personal liability by filing for bankruptcy.
If the lender waives the deficiency and issues you an IRS Form 1099-C (“Cancellation of Debt”), you might have to report the forgiven debt as taxable income.
If you need help arranging a short sale, dealing with a foreclosure, or want to learn the law on deficiency judgments after short sales in your state, consider talking to a foreclosure lawyer. A HUD-approved housing counselor can also provide you with information about different options to avoid a foreclosure, like a short sale.