Homeowners who have gone through a short sale are sometimes surprised months or years down the line when their lenders seek deficiency judgments against them. While many states have laws that prohibit lenders from suing borrowers for deficiencies after foreclosure, most of these laws don’t address whether these anti-deficiency protections apply to transactions outside of foreclosures, such as short sales. (The state of California is a notable exception, prohibiting all lenders who sign off on the terms of a short sale from suing the borrower for any deficiency.)
If your state allows—or at a minimum fails to prohibit lenders from pursuing—deficiency judgments after a short sale, there are a number of ways you can avoid having to pay back the deficiency. (To find out whether your state has a law barring deficiency judgments after a short sale, find the link to your state’s page in our section on State Foreclosure and Deficiency Laws.)
When negotiating with your lender for approval of your short sale, ask the lender to provide in writing a release from liability for the deficiency. The release should say something to the effect that the short sale is in full satisfaction of your mortgage debt or that the lender waives its right to the deficiency. Your real estate broker can negotiate for the release on your behalf, or you can get free help from a HUD-certified housing counselor.
If your lender balks at giving you a written release or instead insists in writing that it is reserving its right to recover the deficiency, you may want to offer the lender a small payment in exchange for the release. (Make sure this payment is included in the HUD-1 Settlement Statement at the closing of the short sale to avoid having this payment appear to be an illegal kickback.) Your lender may think that a bird in hand is worth two in the bush, and accept a much smaller payment now over a much larger payment later. Your lender also avoids the expense and uncertainty of trying to collect the deficiency from you in the future.
After the short sale closes, your lender may try to collect the deficiency from you by calling or sending you letters in the mail reminding you that you still owe them money. (The calls and letters may come from your lender’s attorney or a collections agency.) But there’s not much else your lender can do to recover the deficiency short of suing you.
Fortunately, even if your lender can sue you for the deficiency, it doesn’t necessarily mean that your lender will sue you. Lawsuits are expensive, and most borrowers who are forced to complete a short sale of their homes don’t have much in the way of cash reserves or other assets. Your lender will take on the expense of a lawsuit only if it thinks you have the money to repay the deficiency. If you can’t afford to pay the deficiency, it’s likely that your lender knows this and you can safely bet that your lender won’t file a deficiency lawsuit.
If your lender does sue you and is successful in getting a deficiency judgment against you, your lender will acquire other collections tools to add to its arsenal: your lender could freeze your bank accounts, garnish your wages, or place judgment liens on other property you may own. To avoid all this, you may want to negotiate with your lender to settle the deficiency debt for a smaller amount. Collecting a debt from a reluctant debtor can be a lengthy and costly process—your lender may want to avoid wasting the expense and time in exchange for receiving a smaller payment from you. Alternatively, you could negotiate to repay the debt in installments over time.
If all else fails, you may want to consider bankruptcy to get rid of your deficiency debt. Although you probably don’t want to declare bankruptcy for the sole purpose of discharging a deficiency, bankruptcy might be a good option if you have other debts that you’d like to deal with. To learn more about bankruptcy and how it can help void or reduce your unsecured debts, see the Bankruptcy section of this website.