One thing that often confuses people about the foreclosure process is the concept of a deficiency judgment. First, let’s clear up some misconceptions. A “deficiency” and a “deficiency judgment” are two different things. A deficiency is a dollar amount, which is the difference between the proceeds from the foreclosure sale and the remaining mortgage loan balance. A deficiency can also result from a short sale or a deed in lieu of foreclosure if the short sale or deed in lieu of foreclosure documents do not clearly state that the transaction is in full satisfaction of the debt. The lender can try to collect a deficiency amount by making collection calls or sending demand letters, but the borrower can ignore such collection efforts unless and until the lender obtains a court order. A deficiency judgment is such a court order, and it allows the lender to collect the deficiency amount by garnishing wages, freezing bank accounts, or collecting against the estate if the borrower is deceased.
The relevant statute in Minnesota (Minnesota Statutes, Section 582.30, Subdivision 2) states that a deficiency judgment is not allowed if a mortgage is foreclosed nonjudicially (called “foreclosure by advertisement” in Minnesota) and has a redemption period of six months (typical for nonjudicial foreclosures) or five weeks (which applies to certain abandoned properties). A redemption period is the time period during which, if the owner wants to keep the property, he or she must pay off the total amount that was bid at the foreclosure sale, plus interest. The majority of borrowers are entitled to a six-month or five-week redemption period. Moreover, most foreclosures in Minnesota are nonjudicial. So this means that most foreclosed homeowners will not have to worry about a deficiency judgment because the amount that the bank receives from the foreclosure sale is considered to be in full satisfaction of the mortgage debt. However, if a lender forecloses judicially (called a “foreclosure by action” in Minnesota) instead of nonjudicially, then a deficiency judgment is possible.
With both short sales and deeds in lieu of foreclosure, a lender can potentially claim that a deficiency is owed on the remaining balance following the transaction. The statute in Minnesota that limits deficiency judgments following nonjudicial foreclosures of properties with a redemption period of six months or five weeks does not apply to deficiencies after a short sale or deed in lieu of foreclosure.
If you choose to complete a short sale or a deed in lieu of foreclosure, it is critical that you recognize that a deficiency is possible so as not to be surprised if the lender tries to collect after the transaction is completed. You need to negotiate that the short sale or deed in lieu of foreclosure is in full satisfaction of the debt and ensure that this is clearly stated in the short sale or deed in lieu of foreclosure documents. Be sure to read the documents carefully and ensure that the terms pertaining to a deficiency are agreeable to you before signing.
For more information on foreclosures and deficiency judgments, you can refer to Minnesota Statutes, Chapter 580 (Mortgages; Foreclosure by Advertisement), Chapter 581 (Mortgages; Foreclosure by Action), and Chapter 582 (Mortgages; Foreclosure, General Provisions).