When a borrower takes on a mortgage they sign a promissory note to repay the amount the lender advances. The mortgage is a deed of trust on the property, but after a foreclosure or short sale there may still be a shortfall between the amount on the promissory note and the amount the lender realized through foreclosure, or the amount the homeowner raised through a short sale. The lender in many instances has the right to obtain a judicial deficiency judgment, allowing the shortfall amount to be pursued.
Lenders are actually restricted by individual state laws over their rights to obtain deficiency judgments, and even when allowed each state imposes different rules. Individuals should check their own state statutes and codes to find out the laws of their state. Some states are ‘non recourse’ states and don’t allow lenders to pursue deficiency judgements, but second mortgages are rarely covered by this exemption.
Borrowers who implement a short sale in order to avoid foreclosure should ensure that a release is obtained from the lender at the time of sale to avoid the possibility of a future deficiency judgement. Most states only allow deficiency judgments limited to the fair market value of the property, rather than the full amount of the loan, when negative equity is in place.
Those who live in states which allow for deficiency judgments should be aware of their states rules. Some states demand that lenders must apply for a judgment immediately after foreclosure whilst others allow lenders to wait up to five years before filing. Once a lender has obtained a judgment there can be up to 20 years allowed to pursue the debt which continues to accrue interest.
Historically not many lenders followed up with deficiency judgments as borrowers were mainly going through foreclosure as a result of financial hardship. However the current market has strategic defaulters walking away from homes with negative equity who are current on other debts, investors, and others who have assets. Thus there is a predicted increase in lenders pursuing the outstanding amount still owed.
Lenders may either pursue the debt themselves or can sell on the promissory note to outside collection agencies. Collection methods can include freezing of personal bank accounts and garnishing wages. Non exempt assets can be taken to sell towards the debt. The debtor can have a deficiency judgment wiped out by filing for Chapter 7 bankruptcy, or could try to negotiate a reduced settlement of the full amount still outstanding.
Anyone who goes through foreclosure or a short sale should make themselves aware of their individual state laws regarding deficiency judgments, and speak to their lender regarding the possibility. It is also advisable to take legal advice if the state is one which does allow deficiency judgments to be pursued, rather than live under the shadow of possibly receiving on several years down the line.