If you're facing a foreclosure or short sale, very little seems worse than the prospect of losing your home to your mortgage lender. Unfortunately, many former homeowners may be in for a particularly nasty surprise. Banks often have the right to file a lawsuit for a mortgage deficiency judgment and continue to pursue borrowers for their unpaid mortgage debts.
How a Mortgage Deficiency Occurs
After a foreclosure, the mortgage lender will attempt to sell the property either at a foreclosure auction or on the open market. If the price the lender gets for the home is less than the amount of money theyou owed on your mortgage loan, you're still legally responsible for the difference.
Short sales are even more dangerous. In some cases, a homeowner who loses his home to foreclosure has built sufficient equity in the house to allow the mortgage lender to recover the full outstanding mortgage balance. This is never true of a short sale. The very basis of a short sale is the fact that the lender agrees to allow you to sell your home for less than you owe on your mortgage loan. Thus, short sales always create a mortgage deficiency. In certain circumstances, a forgiven mortgage deficiency may carry a tax penalty.
See: Paying Taxes on Forgiven Debt
Mortgage Lender May File a Lawsuit to Obtain a Deficiency Judgment
Once a mortgage deficiency exists, a mortgage lender can forgive the deficiency and claim the debt as a business loss on its taxes or it can sue you and attempt to recover the unpaid amount of the original home loan through the state's available legal channels.
Should a mortgage lender opt to sue, you will be notified of the lawsuit via a court summons. If you wish to contest the lawsuit, you must respond to the summons and appear in court. Failure to do so will result in the court judge awarding a mortgage deficiency judgment to the lender by default.
In some cases, a mortgage lender may opt to sell its outstanding mortgage deficiencies to a collection agency which will then file lawsuits against each of the debtors.
Consequences of a Mortgage Deficiency Judgment
Once a lender or collection agency wins a mortgage deficiency judgment, it will take legal action to enforce the debt. A judgment often grants the judgment creditor the right to forcibly seize payment for the deficiency in one of the following ways:
- Wage garnishment
- Bank levies
- Property liens
Even if the judgment creditor opts not to pursue its legal debt recovery options following a lawsuit, the judgment itself still appears in the public record – and ends up on your credit report.
See: How a Collection Judgment Can Hurt Credit
Not Every Lender Will Pursue a Mortgage Judgment
Mortgage lenders that hold a second mortgage on a property are much more likely to actively pursue a mortgage deficiency judgment than the primary lien holder. The reason for this is that the primary lien holder may take a loss, but receives the property. The property serves as compensation for at least a portion of the debt that you still owe on your home loan. For many mortgage lenders this is sufficient since pursuing a mortgage deficiency judgment can be costly and time consuming.
If you took out a second mortgage on the property, however, the second mortgage lender is unlikely to receive any compensation for the debt following a foreclosure or short sale. This makes it more likely to seek a civil judgment to force you to repay the mortgage loan.
Some mortgage lenders won’t take former homeowners to court over mortgage debt that remains after a foreclosure or short sale because they aren’t permitted to. If you live in a “non-recourse” state, your mortgage lender cannot sue you for any loss it incurs through the seizure of your property.
Reduce the Chance of a Mortgage Judgment After a Short Sale
For consumers negotiating a short sale that do not live in a non-recourse state, avoiding a mortgage judgment due to a loan deficiency is a fairly simple process. As long as the mortgage lender includes, in writing, that it will not legally pursue the consumer for the unpaid deficiency of the mortgage loan, the consumer can safely proceed with the short sale.
A mortgage deficiency judgment can cost an individual tens of thousands of dollars and years of grief. For a consumer who could not imagine anything worse than losing his home, a mortgage deficiency judgment is a bitter pill to swallow. After all, the only thing worse than losing a home is being forced to pay for the home long after its gone.
Sources:
State of California Franchise Tax Board: California Code of Civil Procedures and Foreclosures
U.S. Marshal's Service: Service of Process
Candice Edwards - Candice Gillingwater is a credit specialist and consumer advocate currently living in Georgia. Her goal is to educate the public about ...
