It's common that a deficiency balance remains after a foreclosure sale is complete. Whether the mortgage company chooses to pursue the deficiency balance depends on the amount of the deficiency and state law.
Written by Attorney John Coble.
Updated October 19, 2021
When a creditor forecloses on your home, it will be sold at auction. If the foreclosure sale price isn't enough to pay off the outstanding mortgage debt, a deficiency balance will remain. If the mortgage is a recourse loan, the court may then grant the creditor a deficiency judgment, and the creditor can then sue you to recover the remaining debt.
How Does a Foreclosure Work?
The type of foreclosure your mortgage company uses will impact you in a number of ways. It may be the case that the mortgage company pursues a judicial foreclosure. If so, the foreclosure process will take longer, but it will be easier to defend against this action as a result. A creditor can obtain a deficiency judgment during the judicial foreclosure process.
If the mortgage company pursues a non-judicial foreclosure, it will likely progress quicker than a judicial foreclosure would. In a nonjudicial approach, the mortgage company will have to file a separate lawsuit to obtain a deficiency judgment. Some states bar a mortgage company from seeking a deficiency judgment unless they use a judicial foreclosure. Some states prohibit deficiency judgments on real estate that was the debtor’s primary residence.
With a judicial foreclosure, the mortgage company must go to court and get a judge's permission before they begin foreclosing on your real property. Navigating a lawsuit, judgment, and a sale takes time. As a result, a judicial foreclosure process can take two years or longer to complete. Because of the backlog in many courts due to COVID-19, you can expect these procedures to take even longer.
A non-judicial foreclosure is the more common type of foreclosure. It's much quicker since the mortgage company doesn't need to file a lawsuit before beginning the foreclosure process. A nonjudicial foreclosure process may require as little as a homeowner missing a few months of your mortgage payments and a law firm running three weeks of advertisements of the foreclosure sale in the legal notices of a local newspaper for the mortgage company to begin the foreclosure process.
States are somewhat divided into judicial and nonjudicial foreclosure states, although some states allow both processes. Only five states and the District of Columbia prohibit judicial foreclosures. All other states allow judicial foreclosures. Most states also allow non-judicial foreclosures. Only those states that prohibit non-judicial foreclosures are called judicial foreclosure states. There are twenty judicial foreclosure states and thirty non-judicial foreclosure states.
In some states that allow nonjudicial foreclosures, a mortgage company must opt for a judicial foreclosure or they won’t be permitted to seek a deficiency balance. In other states, companies may use a non-judicial foreclosure process and then, after the sale, go to court to seek a deficiency balance when the fair market value of the property is less than the loan amount due.
What Is a Deficiency Judgment?
Foreclosure sales are often conducted by auction on the courthouse steps. A court clerk may come out and call for bids. The only bidder may be a representative of the mortgage company. It's common for people passing by to have no clue what's going on. In some non-judicial foreclosure states, the foreclosure notice is only required to give the date of the sale and say the time of foreclosure is "during the legal hours of sale." In at least one state that allows this practice, the legal hours of sale are any time between 11:00 AM and 4:00 PM. For this reason, few bidders show up. With few bidders, the homes are rarely sold for fair market value, increasing the amount of the deficiency even further. The former homeowners remain responsible for this debt.
After a foreclosure sale, there is a brief redemption period. During the redemption period, if you're able to find enough money to pay off your mortgage balance, you can pay off the balance and your home will be returned to you. These redemption periods vary by state law. In some states, when a mortgage lender seeks a deficiency judgment, the redemption period restarts.
Most states have significant limitations on a mortgage company’s ability to seek a deficiency judgment against you. Many states have made deficiency judgments after foreclosure illegal. As a general rule, in the states that allow deficiency judgments, the mortgage company must prove to the court that it didn’t accept a low-ball bid at the foreclosure sale. A low bid accepted at the sale would cause the amount of the deficiency to be much higher.
Where the courts apply this rule, the mortgage company will have to show the court that houses of comparable value in that area sold for prices similar to what was accepted at the foreclosure sale. An example of the application of this rule would be as follows: You owe $200,000.00 on your mortgage. The mortgage company sells your home for $150,000.00 at a foreclosure sale. If you live in an area where the court requires a good faith foreclosure sale and it’s determined by the court that homes of comparable value were recently selling for $225,000.00 in your area, the court will probably deny the mortgage company’s claim for a deficiency judgment.
Can I Avoid a Deficiency Balance if My Home Is Foreclosed?
There are ways to prevent a deficiency balance. You could negotiate with your mortgage company or debt collector before a foreclosure process is complete. It's often the case that the mortgage company will waive a deficiency balance if you agree to the foreclosure. This is called a deed in lieu of foreclosure. This approach is generally “worth it” to the mortgage company when the mortgage company has to assume great expense to complete the foreclosure process. This is especially true in judicial foreclosure states.
If the mortgage company waives your deficiency judgment with a deed in lieu of foreclosure, you could suffer serious tax consequences. They will issue a Form 1099 for forgiven debt. §108 of the Internal Revenue Code requires forgiven debt to be treated as if it were income received by you. Hence, you will have to pay taxes on this forgiven amount just as if you had received the money on your paycheck. If you receive such a Form 1099, you should see an accountant. You may be able to reduce the amount included in income to the extent you're insolvent. See Form 982 for how insolvency is calculated. If you receive a Form 1099 for debts forgiven, you can avoid having to include this money in your taxable income by filing for bankruptcy. §108 of the Internal Revenue Code has an exception to forgiveness of debt income for debts discharged in bankruptcy.
What Does a Mortgage Company Do With a Deficiency Judgment?
Mortgage companies use the same collection procedures as any other creditor that gets a judgment against a debtor. If a judgment is obtained against you, a creditor can refer the matter to a debt collector, garnish your paycheck, take money from your bank account, and put liens on everything you own.
A wage garnishment forces your employer to take the money from your paycheck and send it to the creditor. If your employer doesn't comply with the garnishment order, your employer may have to pay the money itself. Federal law prohibits a creditor from taking more than 25% of an individual’s disposable earnings. For lower-income wage earners, the federal limit may be lower than 25%. If the mortgage company uses a bank levy, the bank must take the money out of your account and send it to the creditor. You may be able to get some of this money back by using your state law exemptions.
A creditor may also put a lien on your property. In this case, a creditor can take your real or personal property and sell it to raise money to pay off the balance. It's rare for a creditor to do this. It's more common for the creditor to attach a lien to your property and leave it there. When you choose to sell property such as a car, the creditor will use the lien to force the proceeds of the sale to go to that creditor instead of to you.
As with any other creditor, bankruptcy can be used to stop a mortgage company from collecting a deficiency judgment. The automatic stay stops all collection activity during the bankruptcy. Whether a judgment can be discharged in bankruptcy depends on whether it's a secured debt or an unsecured debt. If the creditor records the judgment in your county records office before you file bankruptcy, the judgment may be treated as a secured debt. The collateral is the non-exempt equity in everything you own.
It is common that a deficiency balance remains after a foreclosure sale is complete. Whether the mortgage company chooses to pursue the deficiency balance is dependent on state law. When the legal hurdles to reach a deficiency judgment after a foreclosure are low, it's more likely the mortgage company will sue you for the deficiency.
Filing for bankruptcy is an option before or after a deficiency judgment. However, it’s ideal to file before the mortgage company records a deficiency judgment and gets a judicial lien against you.
If you have a straightforward bankruptcy case, you may benefit from using Upsolve's free tool to file a Chapter 7 bankruptcy. For more complex cases, you will need to contact an experienced bankruptcy attorney in your area.