When a house is sold in foreclosure for an amount less than the outstanding mortgage debt, the difference between the outstanding loan amount and the foreclosure sale price is called the deficiency. For example: Bob Borrower owes $500,000 on his mortgage from Larry Lender. Bob stops making mortgage payments, Larry forecloses, and Bob’s house is sold at a foreclosure auction for $400,000. The deficiency in this example is $100,000 ($500,000 minus $400,000).
In most states, lenders can sue borrowers to recover the deficiency. If the court awards the lender a deficiency judgment, the lender can use the judgment to garnish the borrower’s wages or freeze the borrower’s bank accounts until the deficiency judgment is paid off.
The laws governing deficiency judgments vary from state to state. Some states give lenders an unfettered right to seek deficiency judgments after a foreclosure sale. Others allow deficiency judgments if the foreclosure goes through court (called a judicial foreclosure) but not if the foreclosure takes place outside the court system (called a nonjudicial foreclosure). Other common limitations include prohibitions against deficiency judgments in foreclosures of mortgages used to purchase a borrower’s primary residence and restrictions on the amounts that may be recovered in a deficiency lawsuit.
To find out what the law covering deficiency judgments is in your state, see our article on Anti-Deficiency Laws.
Because of the time and cost involved in seeking a deficiency judgment, as well as the fact that most debtors who have lost a home in foreclosure are “judgment proof” (that is, they have no assets that the lender can take to collect on the judgment), lenders sometimes choose not to seek a deficiency judgment. Of course, knowing that a lender may not seek a deficiency judgment is small comfort to many homeowners facing foreclosure. They want to know—definitively, yes or no—whether they will be liable for the deficiency or not. Unfortuntately, with lenders looking for new ways to recoup their losses, deficiency judgments are becoming more common.
If you’re behind on your mortgage payments and you’ve come to terms with losing your home, you should contact your mortgage servicer to find out if you are eligible for any foreclosure alternatives, such as a short sale or deed in lieu of foreclosure.
In a short sale, your lender approves the sale of your home for less than you owe on your mortgage. The difference between the sale price and the total debt amount is the deficiency.
In a deed in lieu of foreclosure, you sign your home over to your lender, and in exchange your lender foregoes foreclosure and releases you from your mortgage. (With a deed in lieu of foreclosure, the deficiency amount is the difference between the fair market value of the property and the total debt.)
Whether you pursue a short sale or deed in lieu of foreclosure, you should try to get your lender to agree in writing to release you from liability for any remaining debt.
If you’re unable to complete a short sale or deed in lieu of foreclosure, and your house is then sold in foreclosure, filing for bankruptcy will eliminate your liability to repay any deficiency. Although you probably don’t want to file for bankruptcy for the sole purpose of getting out of repaying a deficiency, if you’re already considering bankruptcy, the elimination of any deficiency liability is an added benefit.