Once a homeowner decides that a mortgage is no longer affordable and that it’s time to move on, the homeowner must generally choose from one of three options: allowing the home to be sold in foreclosure, selling the home in a short sale, or transferring title to the home directly to the lender with a deed in lieu of foreclosure. Whether the borrower sells the home through a short sale or the bank sells the home following a foreclosure or a deed in lieu of foreclosure, the final sale price may not be enough to cover the total amount that the homeowner owes to the bank. For example, if a homeowner owes $300,000 on a mortgage, and the home sells for only $250,000, there is a gap between the outstanding debt and the sale price of $50,000. This gap is called a deficiency.
Under certain circumstances, the lender may be able to sue the borrower to recover the deficiency. With a deficiency judgment from the court in hand, the lender has the right to garnish the borrower’s wages, freeze the borrower’s bank accounts, and place liens on the borrower’s other assets. The law on deficiency judgments varies greatly from state to state. Read on to find out whether deficiency judgments are allowed in New York and under what conditions.
Deficiency Judgment Following Foreclosure
All foreclosures in New York must go through the judicial system, requiring the lender to sue the borrower in court in order to foreclose. Following a judicial foreclosure in New York, the lender may sue the borrower for all or a portion of the deficiency. The deficiency judgment is limited to the difference between the total debt amount (including the costs incurred by the lender in connection with the foreclosure proceeding) minus the fair market value of the property or the foreclosure sale price (whichever is higher). N.Y. Real Prop. Acts. Law § 1371.
Going back to the above example, if the borrower owes $300,000 (assuming for purposes of this example that this number includes all of the lender’s foreclosure costs), and the home sells for $250,000.00, but the fair market value of the property is $275,000, then the borrower will be liable only for $25,000 (the outstanding mortgage debt minus the fair market value of the property), rather than the actual amount of the deficiency of $50,000 (the outstanding mortgage debt minus the foreclosure sale price). If the home sells for more than its fair market value, the borrower will be liable for the actual amount of the deficiency.
In order to obtain a deficiency judgment, the lender must file a motion for deficiency judgment within 90 days of the consummation of the sale (delivery of the proper deed of conveyance to the purchaser). Regardless of whether the lender files a motion for deficiency judgment, if the receiver (the individual appointed by the court to control the property during foreclosure proceedings) is in possession of any additional funds relating to the property, such as rental income, at the completion of the foreclosure sale, all such funds will be paid to the lender and deducted from the deficiency amount. N.Y. Real Prop. Acts. Law § 1371.
Deficiency Judgment Following a Deed in Lieu of Foreclosure
New York law does not prohibit the lender from recovering the full deficiency amount following a sale in connection with a deed in lieu of foreclosure. However, a lender will often forgive or reduce the amount owed on account of the deficiency during the process of negotiating the terms of the deed in lieu of foreclosure. The borrower should ask the lender to include in the deed in lieu of foreclosure agreement language releasing the borrower from all obligations under the mortgage upon the closing of the deed in lieu of foreclosure transaction.
Deficiency Judgment Following a Short Sale
If the borrower sells the home through a short sale in order to prevent foreclosure, New York law does not prohibit the lender from recovering the amount of the deficiency. However, borrowers may be able to negotiate more favorable terms while discussing the terms of their short sale with the lender; some lenders will agree to reduce or forgive the deficiency amount upon the completion of a short sale.
See also: Risks of a Short Sale
If the lender forgives all or a portion of the deficiency, the amount of the forgiven debt may be considered taxable income. However, under certain circumstances, forgiven debt may be excluded from taxable income. To learn more about the tax consequences of forgiven deficiency debt, see our article Income Tax Liability for Deficiencies.