What Is a Deficiency Judgment?

What's a Deficiency Balance?

The prospect of losing your home to foreclosure is bad. But things could get worse if the value of the property is less than what you still owe on the mortgage. If this happens, you could owe your lender a deficiency balance.

A deficiency balance is the difference between your mortgage balance and what your home sells for at a foreclosure auction. Your lender could get a deficiency judgment from the court allowing them to collect this deficiency balance. Each state handles deficiency judgments differently, so read on to learn more.

What's a Deficiency Judgment? 

Lenders sell foreclosed properties so they can use the cash from the sale to pay off the mortgage debt. But sometimes, there isn’t enough money from the sale to fully pay off the mortgage loan amount. When this happens, the remaining amount is called a deficiency balance. 

A deficiency judgment is what the lender receives after a court approves their request to collect the deficiency balance. After getting the deficiency judgment, the lender can then take steps to collect the remaining balance. A popular tactic involves garnishing wages. Deficiency judgments don’t just exist with foreclosures. They can also come up following a short sale or deed in lieu of foreclosure. 

What Is Foreclosure? 

When someone wants to buy real estate, such as a home, they often have to borrow money to make the purchase. One of the most popular types of loans used to do this is the mortgage loan. This is a type of secured debt that uses the borrower’s property as collateral for the loan. But if the borrower defaults on the mortgage loan, the lender usually has the right to foreclose on the property. During foreclosure, a lender takes and sells the borrower’s property and uses the proceeds to pay off the mortgage loan debt. 

The two most common types of foreclosure are judicial and nonjudicial. In a judicial foreclosure, the lender files a lawsuit to get a court order, which allows the foreclosure to proceed. In a nonjudicial foreclosure, the lender can foreclose on a property without a court order.

What Does the Foreclosure Process Look Like?

Both foreclosure types begin with a borrower missing multiple mortgage payments. The lender then sends a letter to the borrower telling them to become current with their mortgage or risk defaulting. If the borrower can’t make up the missed payments, the lender will either send the borrower a Notice of Default or begin a foreclosure lawsuit. Assuming the borrower isn’t successful in contesting the foreclosure, the property goes to a foreclosure sale. After the property gets sold, the borrower will have to leave, either on their own or through an eviction.

Foreclosures are devastating for homeowners. They not only result in the loss of your home but also cause significant damage to your credit score.

Can Anything Protect You From a Foreclosure Deficiency Judgment?

State laws for deficiency judgments differ widely. For example, in some states, lenders aren’t allowed to collect deficiency judgments for home foreclosures. These jurisdictions have special non-recourse laws that prohibit mortgage companies and lenders from filing deficiency lawsuits. These state laws make it easier for homeowners to walk away from their mortgages. 

Despite these protections for borrowers, these laws don’t apply to all borrowers or in all situations. Many of these anti-deficiency judgment laws only protect homeowners who lose their primary residence to foreclosure after defaulting on their first mortgage. So if the foreclosure involves a vacation house or a second mortgage, then a deficiency judgment may still be possible. Another potential exception involves homes acquired through short sales. Here, lenders can sometimes get a deficiency judgment.

In states where deficiency judgments are permitted, lenders may be limited on what they can recover. For instance, the deficiency balance could be limited to the difference between the debt and the fair market value of the property. This is in contrast to a deficiency balance that involves the mortgage debt balance and what the property sells for at a foreclosure sale.

How Do Deficiency Judgments Work?

A deficiency judgment can only be issued if a borrower has violated the terms of their promissory note. The promissory note is the contract that borrowers sign promising to repay the lender the money they’re borrowing. The exact procedure for getting a deficiency judgment depends on if the foreclosure was judicial or nonjudicial.

In a judicial foreclosure, some states make the lenders ask the court for a deficiency judgment as a part of the underlying foreclosure case. Other states may make lenders wait until after a judicial foreclosure to get the deficiency judgment. In a nonjudicial foreclosure, the lender has to wait until they complete the foreclosure. Then they sue the borrower to get the deficiency judgment.

If a lender sues for a deficiency balance after the foreclosure action, they must prove to the court that the property sold for a reasonable price. In other words, the court wants to make sure the lender didn’t accept a low-ball offer on the home. The lender must show that the foreclosure sale price was comparable to other foreclosed properties in the area.

Collection Measures Following a Deficiency Judgment

After getting a deficiency judgment, the lender has multiple ways to collect the deficiency balance. The most common options include:

• Wage garnishment: Wage garnishment occurs when an employer takes a portion of each of a borrower’s paychecks and sends it to the lender. The total amount garnished from each paycheck is typically limited to 25% of the borrower’s disposable income.

• Bank account levy: These are similar to garnishments in that the lender gets a court order to take money from a borrower. In this case, they take it out of the borrower’s bank account instead of their paycheck. States differ on how much money the lender can take through a bank account levy.

• Property lien: A lien is a legal right that a creditor attaches to a borrower’s property to protect the creditor’s ability to collect a debt. A lender may place a lien on the borrower’s property to prevent them from selling the property until the debt gets paid.

How To Avoid a Deficiency Judgment 

If you’re in a state that allows deficiency judgments, you have several options to avoid them. First, you can file bankruptcy. Some deficiency balances are dischargeable in bankruptcy. this will depend on which type of bankruptcy you file.

Second, you can present evidence in court showing the foreclosed property’s selling price wasn’t reasonable. 

Third, if you’re thinking about a short sale or deed in lieu of foreclosure, you can ask your lender to waive its right to a deficiency judgment. Some banks and mortgage foreclosure companies will agree to do this.

Fourth, you can reach a settlement with your lender. Going to court for a deficiency judgment can be expensive. As a result, lenders may be willing to forego their right to collect the full amount of the deficiency. In return, they get a lump-sum cash payment for part of the deficiency balance amount.

Let's Summarize... 

A deficiency judgment is a court order granting a lender the right to collect a deficiency balance. A deficiency balance is the amount of money a borrower owes a lender even after the lender has foreclosed on the borrower’s home. This can occur if the property is worth less than the balance on the mortgage loan.

To get a deficiency judgment, most lenders need to request one from the court. Depending on the type of foreclosure, this can take place during the foreclosure process or after. Once a lender receives the deficiency judgment, they can collect the money through wage garnishment, a bank account levy, or a property lien. Borrowers can sometimes avoid a deficiency judgment by filing bankruptcy or negotiating with their lender.