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 Wisconsin and under what conditions.
Foreclosures in Wisconsin are judicial. In other words, lenders must sue defaulting borrowers in court in order to foreclose. The foreclosure sale can take place no earlier than a year after the court enters a judgment to foreclose. Wis. Stat. § 846.10. During this time, the borrower has the right to redeem the property by paying the foreclosure judgment plus costs and interest. Wis. Stat. § 846.13. (If the lender waives its right to a deficiency judgment, the redemption period is shortened from twelve to six months. Wis. Stat. § 846.101. The redemption period is five weeks if the borrower has abandoned the property. Wis. Stat. § 846.102.)
Lenders may recover the deficiency after a foreclosure sale so long as they demand a deficiency judgment in the foreclosure complaint. If the lender waives its right to collect any deficiency, the foreclosed property may be sold within six months of the date of the foreclosure judgment. Wis. Stat. § 846.101.
Before confirming the foreclosure sale and rendering a deficiency judgment, the court will determine the fair value of the property. If the fair value of the property is greater than the foreclosure sale price, the amount of the deficiency judgment will be capped to the difference between the outstanding mortgage debt and the fair value of the property. Wis. Stat. § 846.165.
Wisconsin 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, Wisconsin 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 article on the Risks of Doing 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.