Whether or not the bank can collect a Deficiency Judgment from you depends on what your promissory note says and which state you’re in.  More About Deficiency Judgments.  Because your default and any resulting Foreclosure Lawsuit comes from a breach of your promissory note (not the mortgage), you’ll need to read your note carefully to see if it provides for personal liability against you.  Difference Between Your Promissory Note and Mortgage.

However, in some states like California Deficiency Judgments are prohibited on most residential loans (although refinancing can be an exception). California and others like it are called Non-Recourse states because they prevent personal liability on your home loans.  Many other states unfortunately including Florida, New York and Texas permit Deficiency Judgments against homeowners although your loan documents may still protect you.

The best way to avoid a Deficiency Judgment is selecting a Foreclosure Option 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 to 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.

Learn About All Your Foreclosure Options

 Sample Foreclosure Documents and Letters

On the other hand if you just Walk Away or force the bank to pursue a foreclosure lawsuit 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. Read Why Walk Away is Your Worst Foreclosure Option.

A final note about possible tax consequences.  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!  The good news is that at least through the end of 2012, the income will not be taxable for short sales although its unclear if the exemption will be extended.

Even if you can’t get a a resolution to your foreclosure lawsuit before the tax exemption expires in 2012, it’s not all bad news because its one or the other — the bank can’t pursue both collection of a deficiency judgment and calling the loss  income to you 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.

Consequently when you’re negotiating final terms of a short sale or deed in lieu of foreclosure with the bank, tell them your preference and insist  it be included in the final agreement. Make sure to GET IT IN WRITING if its not already part of the final written agreement because verbal promises won’t work.

Related Content:

What to do With Your Second Mortgage

Importance of the Default Notice

Don’t Let Foreclosure Stress Control Your Life

Who Owns Your Mortgage

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