Understanding Deficiency Judgments in Foreclosure: What You Need to Know
Foreclosure is the process by which mortgage lenders will attempt to reclaim their asset when a borrower doesn’t repay their home mortgage according to the terms of the agreement. When borrowers miss payments or get behind on payments, states have strict guidelines about what lenders can and must do in order to start the foreclosure process.
At the end of the foreclosure process, the lender will cause the auction sale to take place allowing a third party to purchase the property or take back control of the home and then sell it to recoup any losses they have incurred from the borrower not paying.
In some states, this is the end of the process. The lender takes the home, sells it and recoups whatever money it can at an auction sale. The borrower loses ownership of the home after their redemption period expires, and their credit is subsequently impacted.
Many states, though, allow for what’s called deficiency judgments. This provides a way for lenders to recoup any deficit that exists between what the home sold for at auction and what was owed on the mortgage.
Below, we describe in-depth what deficiency judgments are, how they work and what a borrower’s options are.
What is a Deficiency Judgment?
A deficiency judgment is an order from a court providing the lender with a money judgment that allows a lender to go after more money directly from a borrower. This can occur if, as mentioned above, the sales price of the home at auction was less than the remaining debt on the mortgage.
If a home has an outstanding debt of $200,000 but only sells for $150,000 at auction, the deficiency amount is $50,000. This is what the lender can seek to recover from the borrower through a deficiency judgment plus additional fees, costs and interest, which can accrue the longer the judgment is not satisfied.
Most commonly, deficiency judgments come after mortgage foreclosures complete. Not every state allows them, though.
Foreclosure Types and Deficiency Judgments
Just like all aspects of foreclosure, each individual state sets the rules and regulations for deficiency judgments.
Foreclosure Sale: Judicial vs. Nonjudicial Foreclosure
There are two main types of foreclosure — judicial and non-judicial. Judicial foreclosure involves the court system and will include an official court order, while a non-judicial foreclosure is a process that happens completely outside of the state court system.
In states where non-judicial foreclosures are allowed, a document within the mortgage paperwork essentially gives the lender the power to sell the home if a borrower defaults on the repayments. In states where judicial foreclosure is all that’s allowed, the court process will result in the lender receiving that right.
It’s important for both homeowners and lenders alike to understand the foreclosure process in their state. The laws that apply depend on where the home is located, and not where the lender is located.
Each state will outline the specific steps required for a foreclosure process to begin, what must be done by when, and whether a borrower has a right to redeem the property — even after it’s sold at auction.
In some states that allow deficiency judgments, lenders must file a lawsuit after the foreclosure to get a deficiency judgment. In most states that allow judicial foreclosures, the deficiency judgment will be part of the underlying foreclosure lawsuit — eliminating an extra step in the process.
Calculating Deficiency Judgments
In states where deficiency judgments are allowed, strict rules are in place to determine how much this judgment is worth — and how much a borrower might have to pay out of their pocket.
This is important in any economic environment, but especially in periods of a downturn in the real estate market. In the last major downturn that happened back in 2018, for example, home values plummeted, causing many homeowners to have a mortgage that was “underwater.”
How Deficiency Amounts are Calculated
The base of deficiency judgments is relatively easy to figure out. They are calculated by subtracting the foreclosure sale proceeds from the current principal balance on that mortgage.
So, if a borrower defaults on a $400,000 mortgage after making a substantial down payment at closing and paying the mortgage down for five years, you’ll need to first determine what the current outstanding balance is. This amount is called the outstanding principal.
In some cases, this amount could be rather close to the original mortgage amount in early years, since so much of a mortgage payment goes toward interest in the front-half of a mortgage. After five years, for instance, the principal balance on the above example could still be around $350,000 — depending on the down payment amount and how high the interest rate was.
If this home then sells for $325,000 at auction after foreclosure, the deficiency amount would be $25,000 — which is the difference between the auction sale price and the principal balance.
Some states also allow for lenders to pursue additional costs that are associated with the foreclosure process.
Lenders Collecting Deficiency Judgments
Since deficiency judgments are court orders, they allow lenders to place liens on a borrower’s other property if they are successful. This could allow them to freeze a borrower’s bank accounts or to garnish their wages to collect on the outstanding debt.
Lenders that win deficiency judgments will collect this debt like all other unsecured forms of debt. Borrowers may not have to pay the full amount upfront, but rather could come up with a payment plan to satisfy this debt.
State Laws and Deficiency Judgments
Each individual state determines what type of foreclosure process is used and whether lenders are able to pursue deficiency judgments for any remaining debt.
States That Allow Deficiency Judgments
All but six states allow deficiency judgments. Only Washington, Oregon, Montana, Minnesota, California and Alaska forbid deficiency judgments in most instances.
There are some other states such as Arizona that have limits on deficiency judgments. In that state, for instance, deficiency judgments are not allowed for one- or two-family homes that sit on 2.5 acres or less.
Unfortunately, not only do deficiency judgment laws vary by state, but they can be very complicated, too. That’s why it’s important for borrowers to consult with an experienced foreclosure law firm in their state if they’re facing mortgage foreclosure and a possible deficiency judgment.
Deficiency Judgment Timeline
How long it takes for a deficiency judgment to put in place again depends on the state in which it occurs. Each state sets a defined process for what has to happen in order for a lender to file a deficiency judgment suit, and how long it takes to proceed through the court system.
Some states require lenders to act immediately after a foreclosure sale is completed, while others have a longer statute of limitation that allows lenders to wait several years to collect a deficiency judgment.
Borrower Options
Borrowers do possess some rights throughout the foreclosure process, including in regard to deficiency judgments. It’s possible that if you’re facing such a judgment, you could request that your lender waive their right to pursue a judgment after the home is sold.
It’s also possible that if a deficiency judgment is put in place, you could file a legal motion to overturn it. However, this process could be expensive and time-consuming, and require the help of an experienced lawyer.
If you’re hard-pressed financially, you may consider declaring bankruptcy, which could ultimately result in your debts, including any deficiency judgment against you, being discharged by a bankruptcy court.
Impact on Junior Liens
On most mortgages, senior lien holders hold the ultimate rights to secure their outstanding debt. If you have a second mortgage, home equity line of credit (HELOCS) and other junior loans, those lenders will likely lose their security interest in the real estate property once the senior lien holder forecloses.
The only way that those junior lien holders may receive payment from a foreclosure is if the foreclosure sale amount far exceeds the outstanding principal on the primary mortgage.
Conclusion
Deficiency judgments allow lenders to go after borrowers for any difference in the amount that exists between the outstanding principal on a mortgage and how much the home sells for after a foreclosure. These laws, like all foreclosure laws, differ greatly by state and are sometimes hard to understand.
That being said, it’s very important to understand the foreclosure process and deficiency judgment laws in your state so that you can protect yourself if you’re ever in trouble. Deficiency judgments laws can have a significant impact on not only your credit history but your personal finances as well.
Babi Legal Group is a Michigan-based law firm experienced in many areas of law, including debt collection and settlement, bankruptcy and real estate. If you’re facing foreclosure and/or a deficiency judgment, contact us to find out what your rights are and how we can help you.
