What is a Deficiency Judgment?
A “Deficiency Judgment” refers to the amount of money still owed on your mortgage after a short sale, deed in lieu of foreclosure or your decision to walk away from the mortgage. The remaining amount plus collection costs, attorney’s fees and interest make up the deficiency balance and once the bank obtains a judgment for that balance they have a Deficiency Judgment against you. Unfortunately, because many homeowners are more concerned about immediate foreclosure problems than dealing with potential long term consequences, Deficiency Judgments are often overlooked.
Whether or not the bank can collect a Deficiency Judgment depends on the terms of your loan documents and which state you’re in. Because your default and any resulting foreclosure lawsuit comes from a breach of your promissory note and not your mortgage, you need to determine if the note provides for personal liability against you. Difference Between the Promissory Note and Mortgage.
In some states like California, Deficiency Judgments are prohibited on most residential loans although refinancing your can be an exception. California and others are called Non-Recourse states because they prevent personal liability on your home loans.
Other states, including Florida, New York and Texas permit Deficiency Judgments against homeowners although your loan documents may still protect you. Due to the differences in state law and the varying terms of your note with the bank, we strongly urge you to hire an experienced lawyer if at all possible to help understand both state laws and your loan documents. Always hire lawyers and other professionals from a trusted source and not just a smiling face in the phone book! More on the Foreclosure Process
There are several ways to avoid Deficiency Judgments as discussed below.
How to Avoid a Deficiency Judgment
The best way to avoid a Deficiency Judgment is selecting a foreclosure alternative that lets you control the outcome. By using a short sale or deed in lieu of foreclosure thereby working with rather than against the bank, you’ll be in a much stronger position to demand waiver of the deficiency balance as a condition of working with them. Banks would much rather waive the right to collect a Deficiency Judgment than pursuing a costly foreclosure lawsuit with little or nothing to gain.
Alternatively, if you just walk away or force the bank to pursue a foreclosure lawsuit right to the bloody end, the normally unfriendly banks will be colder than ice and happily chase you down for the deficiency balance and anything else they can get their claws on. Blame the Banks For the Foreclosure Crisis
Possible Tax Consequences From Foreclosure
It’s important to understand that any amount the bank agrees to waive may be treated as income by the IRS. The idea is that you’re supposedly “saving” money by not paying off your mortgage in full which may qualify as income. So, even when the bank agrees to waive your deficiency balance and not pursue a Deficiency Judgment against you, they may still be required to issue a “1099” declaring your income. Can’t win for losing! Don’t Let Foreclosure Stress Make You Sick
It’s not all bad news, however, because its one or the other — the bank can’t pursue both deficiency collection and calling the loss income so there is some control over which method is best for you. For example, since many homeowners involved in foreclosure lawsuits otherwise have little or no income, a 1099 for the difference between your mortgage and the amount paid in a short sale would have little actual financial impact and in that example would prefer to waive the Deficiency Judgment. Florida Foreclosure Lawsuits
In addition, at least through December 31, 2012 the IRS is forgiving taxable income incurred in either a short sale or foreclosure action as long as the lender officially releases the debt. However, on January 1, 2013 the rules change and the amount the lender forgives on a primary residence from either a short sale or foreclosure action will be taxable on federal income taxes. Thus, the timing of your foreclosure plans and option to stop foreclosure may be impacted by the current IRS rules and the changes coming in 2013.
Therefore, when you’re negotiating final terms of a short sale or deed in lieu of foreclosure with the bank, let them know your preference and insist that the lender formally releases the debt as a condition of the final agreement AND GET IT IN WRITING if its not already part of the final written agreement. Verbal promises they’ll “take care of things” won’t work. Tips to get Your Short Sale Approved
Although we’re able to identify this and other matters as potential red flags and areas of concern for you, we strongly recommend that you meet with an experienced attorney, financial adviser, accountant or tax professional as your situation dictates for specific advice pertaining to your circumstances. As always hire from a trusted source and be sure that any professional has experience in the area you need help. Ten Ways to Stop Foreclosure