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 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 Vermont and under what conditions.
All foreclosures in Vermont of residential properties of four units or less that are owner-occupied must go through the judicial system, requiring the lender to sue the borrower in court in order to foreclose. Vt. Stat. Ann. tit. 12, § 4531a. The default method of foreclosure in Vermont is strict foreclosure, which transfers title to the property directly to the lender. However, at the court’s discretion, or upon the motion of any party in the foreclosure suit, the foreclosure may occur by judicial sale, whereby the property is sold at auction and the proceeds are paid to the lender on account of the outstanding debt. Vt. Stat. Ann. tit. 12, § 4531.
In an action for strict foreclosure, the lender may seek a deficiency judgment in a separate lawsuit. In a foreclosure by sale, the court may grant a deficiency judgment following the sale, provided that the lender requests a deficiency judgment in its initial complaint. In the event that the lender purchases the property at the foreclosure sale, then the amount of the deficiency will be limited to the difference between the fair market value of the property and the total amount the borrower owes to the lender pursuant to the mortgage (plus expenses incurred by lender in connection with the sale). Vt. R. Civ. P. 80.1.
Vermont law does not prohibit a lender from suing the borrower for the deficiency after 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. To learn more, see: Deed in Lieu of Foreclosure.
If the borrower sells the home through a short sale in order to prevent foreclosure, Vermont law does not prohibit the lender from suing the borrower to recover 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.
See also: Financial Risks of a Short Sale
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.