For those of us who haven’t experienced foreclosure, the concept is an abstract one. It’s something you want to avoid if you’re a homeowner. It’s the consequence of not staying on top of your mortgage payment. It’s the reason you don’t want to buy more house than you can feasibly afford, and a large part of why conventional wisdom dictates that you should only spend 30% of your monthly income on mortgage payments. In short, most homeowner advice leads back to the notion that foreclosure is bad (obviously) and is to be avoided at all costs.
When a homeowner faces foreclosure, the process is a harrowing one. Most people don’t find themselves in that situation without it being preceded by considerable financial stress or adverse life events such as an illness, divorce, or job loss. By the time the lender moves to foreclose, it’s usually been a long and exhausting road for the borrower. Though losing one’s home and often years of investment is a dispiriting turn of events, the finality of it can make it seem like the end of the road, and at least the borrower can move on.
But what if foreclosure isn’t the final word? Suppose your home sells for less money than you owe on your mortgage note? Do you still owe the lender money?
The short version of the answer is, yes, with some exceptions (like most things in real estate). The longer version is a little more complex. Most mortgage lenders require borrowers to personally guarantee the amount of the note, and that means that the borrower can still be on the hook if the sale of the home doesn’t completely cover the amount owed to the lender.
This remaining debt is known as a deficiency, and yes, lenders absolutely can sue to recover this amount.
For example, if you owe $200,000 on your mortgage and can no longer afford to make payments on the note, the lender will institute foreclosure proceedings against you and will eventually sell your home to recoup the amount owed. If the home sells for $150,000, you’ll still be in the red. Some states allow lenders to collect deficiency judgments, and if that’s the case the lender can obtain one and sue you for the remaining $50,000.
This is, for obvious reasons, a pretty tough pill for the borrower to swallow after losing their home, but it can and does happen. Whether or not it does is dependent on a few things, which we’ll examine below.
The first is the worth of the home vs. how much the borrower owes. If the home will sell at a foreclosure sale for more than the amount owed, then the borrower is obviously no longer in debt to the lender. A lender is obligated to apply the sale price of a home to the mortgage debt. If a home is underwater (the amount owed on the mortgage is more than the home is worth) then the borrower could face a deficiency judgment after a foreclosure.
A deficiency judgment isn’t the same thing as a deficiency; a deficiency is just the difference between the amount owed and the amount collected by the lender in the foreclosure sale. A deficiency judgment is a court judgment and a matter of public record as to who owes how much and to whom. Because it’s a legal proceeding, different states have different requirements. The lender can be allowed to seek a judgment against the borrower for unsecured monies still owed on the balance of the loan, but whether or not they can, and the manner in which they do so, is largely dependent on state law.
There are two basic categories, but tighten your belts because this is about to get complicated. It comes down to the difference between recourse and non-recourse states. In recourse states, a lender is allowed to sue for a deficiency judgment because by state law, and a borrower is held personally liable for the loan. This means the lender can pursue an unpaid balance.
In non-recourse states, a borrower is not held personally liable for the loan. These states only allow the lender to repossess the collateral for the loan, and prohibit the lender from going after the borrower’s personal assets if the sale of the home does not satisfy the mortgage. In other words, the lender must accept that loss.
There are, of course, 50 states, and things get a little more complicated from here. There are slight differences between state law that make it difficult to generalize and apply blanket advice to most homeowners. It really does depend on what state you live in and what its laws are.
Some states have anti-deficiency legislation that make deficiency judgments applicable only to seller-financed or “purchase-money” mortgages. In other words, when the seller of real estate provides the financing for the purchase, the seller/lender is prohibited by law from seeking deficiency judgments. While they are allowed to repossess the collateral (usually the property) as recourse against the unpaid balance, they may not move against the borrower individually. This can exclude banks, who are in some cases are allowed to seek deficiency judgments against borrowers.
How states allow foreclosures can also affect their laws on deficiency judgments. If your state follows the title theory of mortgages (sometimes called trust-deed theory), then they typically allow lenders to pursue non-judicial foreclosure procedures, which are faster but do not allow deficiency judgments.
If your state follows the lien theory of mortgages, then foreclosures require judiciary procedures, which take longer but usually allow deficiency judgments against the debtor (because it goes hand-in-hand with a legal proceeding on the foreclosure). Some states have a limited time frame in which a lender is allowed to seek a deficiency judgment.
There are two takeaways here: the first is that if you owe more on your mortgage than your house is worth, you’re going to want to know if your state’s laws allow for deficiency judgments because you may still owe money even after foreclosure. The second is that it is imperative to consult with an experienced bankruptcy attorney because state law in this regard is extremely complex and varies widely.
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