A deficiency judgment is a judgment that the lender can obtain against a borrower when a foreclosure sale does not produce sufficient funds to pay the mortgage debt in full. With a deficiency judgment in hand, the lender can then attempt to collect the deficiency by garnishing the borrower’s wages or taking the borrower’s non-exempt assets.
Because the foreclosure process in Colorado is quite different from other states, borrowers are often confused about whether or not a lender can obtain a deficiency judgment against them and when a court might grant it. A foreclosure in Colorado is unique in that it is the only state where the process consists of a power of sale foreclosure (nonjudicial) conducted by a public trustee (nonjudicial foreclosures in other states are administered by private trustees) that also has an element of court supervision. In Colorado, the public trustee cannot conduct the foreclosure sale until a court authorizes the sale. Before the court authorizes the sale, the lender must present to the court evidence that it has the right to foreclose in what is known as a “Rule 120” hearing, which is named for Rule 120 of the Colorado Rules of Civil Procedure. This hearing provides a court-supervised procedure in a nonjudicial foreclosure that ensures that the foreclosure is proper. However, if the borrower does not file a response to a Rule 120 hearing notice, then the hearing is cancelled, and the court will issue a foreclosure order without holding the hearing.
In Colorado, the lender can obtain a deficiency judgment, but not as part of the foreclosure process. The lender must file suit on the promissory note, which means a separate lawsuit must be initiated against the borrower after the foreclosure. This action must be brought within six years following the foreclosure.
Additionally, Colorado’s foreclosure law requires that the lender bid at least a good-faith estimate of the fair market value of the property at the foreclosure sale. Colo. Rev. Stat §38-38-106(6). Consequently, a deficiency judgment is only available if the lender bids at least its good-faith estimate of the fair market value of the property and the total debt exceeds this amount. The amount of the deficiency is capped at the difference between the debt and the bid. If the lender does not bid the fair market value, the borrower may raise this as a defense in a deficiency proceeding. If the borrower is successful in challenging the fairness of the lender’s bid, then the amount of the deficiency will be a question of fact at trial. A finding by a court that a bid was inadequate does not void the foreclosure sale or prohibit a deficiency judgment, but it will be used to determine the fair amount of the deficiency. Bank of Am. V. Kosovich, 878 P.2d (Colo. App. 1994), Colo. Rev. Stat §38-38-106(6).
While in some states the law will not allow a lender to pursue the deficiency after a short sale or deed in lieu of foreclosure, in Colorado a lender can potentially claim that a deficiency is owed for any remaining debt following either of these transactions.
Short sales are exactly what their name implies--a sale where the proceeds fall short of paying off the total mortgage debt. This inherently creates a deficiency so borrowers need to negotiate that the sale is in full satisfaction of the debt (and make sure that the short sale agreement contains this language) in order to avoid a subsequent deficiency judgment.
A deed in lieu of foreclosure (deed in lieu) is generally considered to be in exchange for full satisfaction of the debt. In many cases, the lender would not be able to obtain a deficiency judgment because standard deed in lieu documents typically state that the deed in lieu eliminates the entire debt. However, what has historically been standard operating procedure for a deed in lieu could potentially change as lenders look for ways to make up losses in a depressed real estate market. If a lender prepares deed in lieu documentation that clearly states the consideration is for less than the full satisfaction of the debt, then that means the lender has the right to pursue a deficiency judgment against the borrower after the transaction is completed. Just like with short sales, if a lender refuses to give up its right to a deficiency in the deed in lieu agreement, it may be possible to negotiate a reduced deficiency.