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 mortgage 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 Connecticut and under what conditions.
All foreclosures in Connecticut must go through the judicial system. In other words, the lender must sue the borrower in court in order to foreclose. The court has the power to choose between a strict foreclosure, which transfers title to the property directly to the lender, or foreclosure by sale, in which the property is sold at auction and the proceeds are paid to the lender on account of the outstanding debt. Conn. Gen. Stat. § 49-24.
In a strict foreclosure, after entering judgment, the court may permit the homeowner a short period of time during which they may reclaim title to the property by paying off the entire remaining mortgage debt (this is called a redemption period). If the borrower fails to redeem the mortgage, the lender has 30 days from the expiration of the redemption period to file a motion seeking a deficiency judgment. The court will then determine the value of the property and the lender will be entitled to the difference between the total debt amount minus the value of the property as determined by the court. Conn. Gen Stat. § 49-14.
In a foreclosure by sale, the lender may sue the borrower for a deficiency judgment following the sale; however, recovery may be limited. Prior to any foreclosure sale, the court will appoint an appraiser to determine the value of the property. If the property sells at or above the appraised value, the lender may sue for the full deficiency. If the property sells for an amount below the appraised value, one-half of the difference between the appraised value and the foreclosure sale price is deducted from the amount of the deficiency that may be recovered by the lender. Conn Gen. Stat. §49-28. For example, if a homeowner owes $300,000 on a mortgage, the home sells for $250,000 at the foreclosure auction, and the appraised value is $280,000, the deficiency judgment will be $35,000.
Connecticut 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.
If the borrower sells the home through a short sale in order to prevent foreclosure, Connecticut 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. To learn more, see our page on The Risk of Short Sales.
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.