A deficiency judgment is an unsecured monetary judgment that a court grants a lender when a foreclosure sale does not bring in enough funds to pay off the entirety of the mortgage debt balance. For example, if a borrower took out a loan for $200,000 to purchase a property, and the sales price at the foreclosure sale is only $150,000, then the lender may obtain a court judgment for the $50,000 deficiency. Deficiency judgments are not allowed in all states.
Texas has three different processes for lenders to foreclose: judicial, nonjudicial, and quasi-judicial. Typically, a home foreclosure will be nonjudicial if the mortgage or deed of trust contains a power of sale clause. A judicial process will be used if there is no power of sale clause, and the quasi-judicial process is utilized for the foreclosure of home equity loans. Nonjudicial foreclosures are most commonly used in Texas.
In Texas, the lender may obtain a deficiency judgment after a nonjudicial or judicial foreclosure. Tex. Prop. Code §51.003, §51.004. In nonjudicial foreclosures, this lawsuit must be brought within two years of the foreclosure sale. Tex. Prop. Code Ann. § 51.003.
As part of the court’s determination of the deficiency amount, the borrower can request that the court determine the fair market value of the property and, if the foreclosure price is lower than fair market value, the borrower is entitled to an offset in the deficiency. For example, if the property sells for $150,000 at the foreclosure sale, but the borrower submits evidence that the fair market value is $175,000 and the court then determines that the actual fair market value is indeed $175,000, then the amount of the deficiency judgment would be $25,000 rather than $50,000. This means that the lender can only collect $25,000 from the borrower.
In order to obtain the offset, the borrower must submit competent evidence of the property’s true fair market value--for example, expert opinion testimony (such as from an appraiser) or by showing comparable sales prices--to arrive at a current fair market value. If the court then decides that the fair market value is greater than the sale price, then the borrower is entitled to the offset. Tex. Prop. Code § 51.003. Since the lender is oftentimes the only bidder at the foreclosure sale, this law prevents them from submitting unfairly low bids at the foreclosure sale in order to pursue a large deficiency judgment from the borrower. However, if the borrower does not request that the court determine the fair market value or if such a request is made and no satisfactory evidence of fair market value is introduced, then the sale price at the foreclosure sale is used to compute the deficiency.
Unlike traditional purchase-money foreclosures, a deficiency judgment is not allowed following the foreclosure of a home equity loan. Texas Constitution, Article XVI, § 50(a)(6)(C).
Nothing in Texas’ foreclosure statutes prohibits a lender from recovering a deficiency following a short sale or a deed in lieu of foreclosure. If you’re considering a short sale or deed in lieu of foreclosure, make sure that the terms of the short sale or deed in lieu of foreclosure agreement clearly release you from the obligation to pay any deficiency.
The laws that govern Texas foreclosures are found in Title 5, Chapter 51, of the Texas Property Code. For information on the special procedures related to home equity loan foreclosures in Texas, see the Texas Rules of Civil Procedure, Part VII, Section 1, Rules 735-736.