Deficiency Judgment Definition

Do you know what a Deficiency Judgment is and how it could harm you financially?

A deficiency judgment is an unsecured money judgment against a borrower whose mortgage foreclosure sale did not produce sufficient funds to pay the underlying promissory note, or loan, in full. The availability of a deficiency judgment depends on whether the lender has a recourse or nonrecourse loan, which is largely a matter of state law. In some jurisdictions, first mortgages are non-recourse loans, but second and subsequent ones are recourse loans.

States that follow the title theory of mortgages typically allow non-judicial foreclosure procedures, which are fast, but do not allow deficiency judgments. States that follow the lien theory of mortgages require judiciary foreclosure procedures, but allow deficiency judgments against the debtor.

Deficiency judgments are court orders that make you personally liable for unpaid debt. They are often associated with foreclosures, when a home’s selling price is not enough to cover the loan balance. Let’s take a closer look at what deficiency judgments are and if you should expect one.

Deficiency Judgment Overview

When you default on a loan and the lender repossesses your property, the value of the property may not pay off the loan. For example, you might owe $100,000 on your home, but it only sells for $80,000. You’re $20,000 short.

Because the lender wants all of the money back, they may take further legal action against you. Legal action to collect the remaining amount is called a deficiency judgment.

Deficiency Judgments

A deficiency is the difference between the fair market value of the property and the amount received, providing the amount received is less than the amount owed.

Whether the bank can pursue a deficiency judgment after a foreclosure or short sale depends in part on whether the promissory note makes the seller personally liable for the debt. Some states allow for personal liability.

Deficiency Judgments in Florida

If your property is sold in a Florida judicial foreclosure and the sale price is less than the actual amount owed, you will be responsible for paying the deficiency. The lender can either forgive this deficient amount or come after you to recover it.

Can lenders get deficiency judgment Florida?

Yes! The lender can obtain a judgment against you to recover the deficiency. He has to file a separate motion/lawsuit for a deficiency once the foreclosure sale is complete. The court then holds a hearing to decide if a deficiency judgment can be allowed against you. At the hearing, the lender has to prove that the property value is indeed less than what you owe.

As a borrower, you have the right to oppose your lender’s claim for judgment. You will have to prove that the property is worth more than the outstanding mortgage balance at the time of foreclosure. You can use an appraisal or the tax assessed value of the property to support your claim.

What happens after lenders get judgment?

Deficiency judgment in Florida allows lenders to come after your wages, levy your bank accounts and put liens on your other properties. However, there are certain assets which are exempt from judgments. They include IRA, 401k, other retirement accounts, social security income, unemployment benefits, workers compensation, etc. Your lender has the right to collect on that judgment for 20 years. The interest will accrue every year till it is paid in full. Apart from this, the judgment will show up on your credit report for 7 years and will affect your credit scores adversely.

Are your wages exempt from garnishment?

If you are the head of the family and your net wages are less than $500 per week, you can protect your wages from garnishment. But if you’ve signed any document allowing the wage garnishment, the lender can come after your wages. In case you are not the head of the family, you can still protect a certain part of your wages. Federal law limits the amount of money that can be garnished by your lender. They can take only 25% of your net wages or the amount in excess of 30 times the federal minimum wage per week, whichever is less.

Are homestead properties exempt from deficiency judgment Florida?

No. Homestead properties are not protected from judgments for mortgage liens. You can protect your home from creditors of unsecured debts under homestead protection. But lenders who have financed purchase, repair, improvement, etc. of your home, hold a lien on your property. If you default on such secured loans, your home is not protected from judgments.

Does PMI help you cover the deficiency?

No. Private Mortgage Insurance (PMI) cannot protect you from deficiency judgments. It is meant to protect a lender against the losses from a mortgage default. A PMI is required if you make a down payment of less than 20% on your loan.

Is there a way to avoid deficiency judgments?

Yes. If you can stop foreclosure, you can avoid the judgment. In case you’re having difficulty in making mortgage payments and a foreclosure is imminent, you can look for various loss mitigation options like loan modification, deed in lieu (DIL), etc. A loan modification can reduce your mortgage payments and help you save the home.

A deed in lieu does not help you retain the home. But it waives off the lender’s right to collect the deficiency. This helps you avoid a judgment. However, you should not believe in verbal agreements. If the deficiency is forgiven, ask your lender to give it in writing before you proceed with the deed in lieu.

Many Florida real estate investors are concerned about personal liability from mortgage foreclosure deficiency judgments. Although they accept loss of equity, if any, in property which is foreclosed by their mortgage lender, people are afraid of a deficiency judgment. A deficiency judgment refers to a mortgage lender’s judgment against the borrower for the difference between the outstanding balance of the mortgage note, plus costs and attorneys fees, and the value of the property foreclosed. The property value is determined on the date of the foreclosure sale. Personal liability from mortgage debt is today a principal reason for asset protection planning.

In judicial foreclosure states, a mortgage foreclosure does not automatically result in a deficiency judgment. Just because you lose a property at foreclosure does not mean you will remain personally liable for money owed to the lender. To obtain a deficiency judgment against the borrower the foreclosure sale the mortgage lender has to file a motion for a deficiency after the foreclosure sale, and the court must hold a separate evidentiary hearing on the lender’s request for deficiency liability. At the evidentiary hearing the mortgage lender has to show the court evidence that the property’s value on the sale date was less than the note balance. The borrower can get his own appraisal or can use the government’s tax assessed value as evidence of value. If the property was worth more than the note balance on the sale date the court will not give the mortgage lender a deficiency judgment against the borrower. The borrower may present evidence of value in the form of a formal appraisal or other less formal opinions of value such as the local government’s tax assessed value.

How has the economy affected judgments?

During the recent real estate boom deficiency judgments were uncommon because increasing real estate values brought home values above note balances of defaulting mortgages. Additionally, lenders could take back “upside down” properties and hold them until the rising market made them whole. Deficiency liability is a problem in a declining market. Up to this point in the real estate crash few mortgage service companies with conventional first mortgages have been pursuing deficiency judgments, especially mortgages on owner occupied homes. Many attorneys and other experts speculate that first mortgage deficiency lawsuits will increase in the future as lenders resolve foreclosure backlogs and as they sell their deficiency rights to third party investors and collection firms. Florida law gives mortgage lenders five years to pursue a mortgage deficiency claim.

What about Second Mortgages and Private Lenders?

Second mortgage lenders and private lenders are more likely than first mortgage holders to go after the borrowers by suing for default on the underlying promissory note. There has been a significant increase in second mortgage lawsuits since the beginning of 2009. Banks that made commercial loans to developers or builders almost always file a lawsuit against the individual borrower to enforce and collect upon the promissory note or personal guarantee of a business loan.

What do I do if the file a Deficiency Judgment?

If a mortgage lender pursues a deficiency judgment you should hire an attorney to defend the deficiency. In many cases, an attorney can use procedural defenses and substantive lending law to defeat a deficiency claim and the attorney can negotiate an acceptable settlement for much less than the total deficiency liability in most cases.

How do I avoid a Deficiency Judgment?

One way to avoid deficiency liability, or to modify your mortgage to avoid foreclosure, is court ordered mediation with your mortgage lender through a new mediation program in Chapter 13 bankruptcy cases. If you file a Chapter 13 bankruptcy in the Orlando division the federal bankruptcy court will very soon after filing issue an order requiring the lender to participate in good faith mediation to discuss mortgage modification.

What about Income Taxes?

Another problem with mortgage foreclosure is possible income tax consequences. The general rule is that when a lender forgives or cancels a debt the borrower can incur income tax on the amount of debt forgiveness. When you arrange a discount in your mortgage in order to sell your house (a so-called “short sale”) the mortgage lender will cancel part of your mortgage debt and you will receive a tax form 1099 telling the IRS that you have imputed income for the amount of debt reduction. You will also incur income tax liability for a deed in lieu of foreclosure. The taxable income will be the difference between the property value and the balance of the mortgage loan on the date you surrender the property to the bank.

A foreclosure may result in cancellation of debt income depending on whether the bank pursues a deficiency judgment. If the mortgage lender gets a deficiency judgment for the difference between the property value on foreclosure sale date and the mortgage balance the lender is not forgiving any part of the loan. If the bank chooses not to pursue a deficiency judgment, or pursues the judgment unsuccessfully, the borrower may incur income tax liability for debt forgiveness.

In December, 2007, Congress acted to protect many debtors from income tax liability associated with foreclosure avoidance. The Mortgage Forgiveness Debt Relief Act of 2007 states that homeowners will not be subject to income tax from release from mortgage liability if and to the extent the mortgage proceeds were used to buy or improve their primary residence. There is no income tax shelter from forgiveness of mortgage debts for investment property, vacation homes, or mortgages used for businesses or to pay off credit card balances. The protection expires in December, 2012. You should speak with an attorney or CPA familiar with the new law to see if you qualify for income tax protection.

For those borrowers who do not qualify for protection of the new Act there is an insolvency exception to imputed income from the cancellation of mortgage debt. If a borrower is financially insolvent when he surrenders the mortgaged property to the lender voluntarily or through foreclosure there will be no imputed income. A borrower who files bankruptcy is presumed to be insolvent, so that a bankruptcy debtor cannot suffer imputed income tax liability because the bankruptcy discharges personal liability under a mortgage note. More information is available from IRS Publication 908 and IRS tax form 982. Both forms can be found at irs.gov.

The tax law permits many real estate investors to offset imputed debt forgiveness income with corresponding tax losses. For example, if a lender forecloses on a parcel of income producing rental property the taxpayer may be able to report an operating loss to offset all imputed income from debt forgiveness in the same year that the mortgage lender issues the Form 1099. When a foreclosed property was not income producing, but was held solely for future appreciation (example: vacant land), the deduction from ordinary income of capital losses in excess of capital gain may be limited to $3,000 per year so that the total loss will have to be deducted over future tax years. You should consult your CPA to determine the tax impact of a mortgage foreclosure on your tax situation. The tax impact of foreclosure is not a legal issue.

Author: Jessica Bennet

Deficiency Judgments in California

The good news for California borrowers is all purchase-money loans on a one- to four-unit residential dwelling are exempt from deficiency judgments.

Hard-money loans in California — loans taken out after the home was purchased through a refinance or second mortgage — can be subject to a deficiency judgment under the following conditions:

  • The lender forecloses under judicial proceedings (California Code Civil. Proc. § 726).
  • Most lenders foreclose through a trustee’s sale; however, which does not give the lender the right to pursue a deficiency judgment, with one exception (see second hard-money second mortgages below).
  • A three-month time limit applies to actions for deficiency judgments under a judicial foreclosure.
  • If the second mortgage is hard money and the lender has lost security for that loan through a foreclosure or short sale — making the security for the promissory note worth nothing — the beneficiary of that second mortgage can pursue a deficiency judgment (Roseleaf Corp. v. Chierighino, 59 Cal. 2d 35 (1963).

Negotiating Collection

Some hard-money lenders sell the promissory note to an investor after a foreclosure for pennies on the dollar. Then, the investor will attempt to collect the debt.

Even though a lender may have accepted, say, $1,000 for a $100,000 second mortgage through a short sale, the security for that hard-money second is released but the promissory note may not be. A short sale seller such as our reader might believe the ordeal is over, until one day he receives a phone call, asking for repayment.

  • Realize that the lender most likely will negotiate for a discounted payoff.
  • The lender may ask for a new promissory note to replace the old promissory note. In that event, make sure the lender sends a “paid in full” promissory note.
  • If the lender has already sold the note, the discount may be greater.
  • Not all hard-money promissory notes must be paid in cash. Some lenders will accept payments.
  • If the lender directs payments to another entity, realize that the note may have been sold at less than its face value, and that new lender may accept an even lower amount as payment in full.
  • After the note is paid in its entirety, ask the lender to return the promissory note marked “paid in full.”
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