A deficiency balance arises when the profits from a foreclosure sale are less than the amount owed on a mortgage. A lender who is owed this debt may pursue it by seeking a deficiency judgment from the court. It is possible for borrowers to negotiate repayment of these balances.
Written by Todd Carney, J.D. Harvard Law 2021.
Updated November 26, 2021
When you’re a homeowner with a mortgage, it can be hard to juggle your house payments and all your other expenses. If you don’t keep up with your payments, your lender can foreclose on your home and sell it at an auction or foreclosure sale. You may believe this frees you from your mortgage debt, but unfortunately, if your home’s sale price doesn’t cover the full amount you owe your lender, you’ll likely still owe your lender money. The amount you could still owe after a foreclosure sale is called a deficiency balance.
Fortunately, the law limits how lenders can pursue deficiency balances. This article will walk you through what a deficiency balance is and the laws that govern these debts.
What Is Included in a Deficiency Balance?
If you fail to make your mortgage payments, your lender has the right to repossess your home and put it up for a foreclosure sale. If your home sells for less than what you owe on the mortgage, you’ll be left with a deficiency balance. The deficiency balance will likely include more than just what you owed minus the amount your home was sold for at a foreclosure auction. It usually includes other costs and fees, such as interest on late loan payments and foreclosure and auction costs. Many creditors will pursue a court judgment to collect this full amount.
So say a borrower owes $100,000 on their mortgage loan. Between late payments and the mortgage servicer’s foreclosure costs, the borrower owes an additional $20,000. At the foreclosure sale, the house sells for $80,000. To calculate the total deficiency balance the borrower owes, we’ll take the loan balance ($100,000), plus the associated costs ($20,000), minus the amount it was sold for ($80,000). That looks like this: ($100,000 + $20,000) - $80,000, which comes out to a $40,000 deficiency balance.
How Lenders Collect on Deficiency Balances
Lenders often work with a collection agency to pursue repayment. Lenders and debt collectors can try to collect on a deficiency in several ways. They may send you debt collection letters, call you, or threaten to damage your credit report. Having unpaid balances can harm your credit score because creditors will report them to the major credit bureaus as a charge-off and/or a repossession. If you have a bad credit score, you may not be able to get loans in the future or you may only be able to get loans with higher interest rates.
If you are going through a repayment plan in an effort to seek debt relief, you can still be subject to these collection methods, depending on whether you declared bankruptcy and other factors. If this becomes a major issue, it might be a good idea to reach out to a bankruptcy attorney for legal advice.
Mortgage companies can also sue you to get a court judgment to collect on the deficiency balance. After receiving a judgment from the court, your mortgage loan provider will be able to pursue more serious collection measures. This includes such as issuing a levy against your bank account and or subjecting you to wage garnishment. Both of these measures allow the mortgage company to take money directly from either your bank account or your paycheck.
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Deficiency Balances on Mortgages
Going through a foreclosure is stressful on its own. Having to figure out how to pay a deficiency balance only makes matters worse. Luckily, several states place limits on deficiency judgments for foreclosed property. For example, in some states, creditors can only pursue a deficiency judgment after a foreclosure if the lender goes through a judicial foreclosure. This means the foreclosure process was done through the court system. This is more time-consuming and expensive for mortgage companies, so they may choose to do a nonjudicial foreclosure when state law allows.
Sometimes states have anti-deficiency statutes that limit deficiencies to only a few situations. California only permits lenders to go after a deficiency when a foreclosure has occurred if a junior lienholder is pursuing it or if the borrower doesn’t actually use the property as their primary home. Additionally, the state forbids deficiencies after a short sale and only allows for a partial deficiency judgment if someone refinances and uses some of the money for something other than their mortgage, such as using it to pay off credit card debt. So any money not used toward the loan can be considered part of a deficiency. Nonetheless, these restrictions make such judgments nonexistent on California’s foreclosures.
Also, many state laws govern how deficiencies are calculated. In these cases, a deficiency balance will be the lesser of:
The fair market value on the date of foreclosure minus the mortgage balance, or
The foreclosure sale price minus the borrower’s mortgage balance.
Deficiency Balances on Other Debts
While foreclosed homes are a common piece of property that may have a deficiency balance, it’s not the only personal property that may be subject to repossession. Cars are another common example of a property that can be repossessed when the borrower defaults on the car loan. You can also end up owing a deficiency balance in this case as well. Many states limit deficiency judgments on cars and other possessions though. One primary limitation is that someone can only pursue a deficiency for a secured debt if the deficiency meets a minimum amount. In Florida, a creditor can only pursue a deficiency judgment if the deficiency is $2,000 or more.
Another limitation concerns repossession sales. For example, a car repossession sale will typically take place at a public auction or through a private sale to a dealer. Many states mandate that all elements of these sales have to be “commercially reasonable.” This is particularly relevant to the sale price because there is a concern that a loan holder would sell your personal property really cheap so they can pursue the rest through a deficiency judgment. Instead, states want the creditors to get as much as possible from the foreclosure or repossession sale before pursuing a deficiency.
On a related note, many states also make a debt collector provide the borrower with a notice of their rights. Going with the car example again, the repossessor needs to provide you with a notice that describes your right to pay off what remains on the car loan in a lump sum before the repossessed vehicle can be sold.
A deficiency balance concerns the remaining amount you owe a lender after they have sold your personal property. This commonly happens when borrowers default on their mortgage and their home is foreclosed and sold, but the sale price doesn’t cover the amount the borrower owes on the mortgage plus any fees or costs related to the foreclosure.
Collections on deficiencies occur the same way as other forms of debt collection: through collection agencies and other legal means. State law regulates how and when lenders and debt collectors can pursue foreclosure deficiencies. Other debts, such as an auto loan, are typically subject to collection limitations based on the value of the deficiency.