Post Closure Deficiency Lawsuits and Judgements
Many homeowners are unaware of options to avoid foreclosure and end up in a dreadful situation that has a profoundly negative effect on their financial future. They also think foreclosure ends the entire loan agreement deal and they are freed from the lender. This is not always true. During the foreclosure period, the borrower must bring the payments current or finish off the loan by paying the due amount. Otherwise, the property goes up for auction. In this article we will discuss the after effects of foreclosure such as deficiency judgment and how to overcome such problems.
What is Deficiency Judgment?
Most people are aware that within the foreclosure period, if the borrower fails to pay the loan amount, the property goes up for auction. At the auction sale, if the home sells for less than the borrower owes (in most cases this happens), the lender or bank has the right to sue the borrower for the balance. This legal action against the borrower for the unpaid balance loan is called Deficiency judgment. Please also note the lender or bank can also sue for the costs related to the foreclosure and pursuit of the deficiency judgment.
Do Banks Really Sue Delinquent Homeowners?
The answer to this totally depends on the bank or the lender, state law and the type of loan. There are two types of loan a borrower can opt for. They are Recourse loan and Non-recourse loan. In case of Non-recourse loan the lenders do not have an option to sue the borrower for loan amount. They can collect the loan amount only through collateral. Non-recourse loans are high risk for lenders and the state law dictates whether a loan is a recourse loan or non-recourse loan. A Deficiency Judgment does not arise in case of non-recourse loan as there is no option for legal actions against the borrower by the lender for the loan amount. In certain states like California, the state law does not permit Deficiency Judgment as the State allows only non-recourse loan.
If the loan is of recourse type, the lenders can sue the borrower. In most of the cases, the lender or bank will not bother with the hassle of processing a Deficiency Judgment. There are two reasons for this, the first one being the cost and the time involved in taking legal action. The second reason is that the banks do not wish to trouble the borrower anymore as the borrower has already suffered a property foreclosure.
How Can I Avoid or Defend A Deficiency Judgment?
After a foreclosure or in-lien of Deficiency Judgment, it is suggested that the default homeowners need seek qualified legal advice through an attorney to arm themselves against a defeat in the form of a Deficiency Judgment. Here we have given ideas of how a borrower can protect themselves from Deficiency Judgment with proper guidance from an attorney:
Know about Mortgage Forgiveness Debt Relief Act:
According to this Act, a borrower who loses their primary residence (principal house; the home they live in) to foreclosure is not subjected to Deficiency Judgment. The unsatisfied debt amount is automatically written off. In such case, if a lender files a lawsuit against the borrower for deficiency judgment, they may not have much of a case because the borrower has the right to defense and counter sue for violation of process and claims. If you have to short-sell your home and you have the right attorney, they can opt for the remaining balance to be written off so no one can come after you. Check with an attorney about your state law regarding debt forgiveness.
What Happens if the Property Foreclosed is Not a Principle Residence?
Since the lenders are aware of the Mortgage Forgiveness Debt Relief Act, most foreclosures happen with properties that are not principle residences. The Mortgage Forgiveness Debt Relief Act cannot protect the deficiency judgment for properties other than principle residences. In this case, the best to avoid deficiency judgements is for the borrower to talk with the lender and negotiate a settlement. Get any agreements in writing and supervised by a lawyer to avoid any future attempts of either seeking a deficiency judgement or sending your balance to a collection agency. Most lenders agree to this as they do not want to waste their time and money dragging the issue out in a long legal battle.
State Law Governing Deficiency Judgment
As explained earlier, if you are residing in non recourse loan state like California, Deficiency Judgments will not come into picture at all. This is because the lenders will be unable to take legal actions against the borrowers after foreclosure. Your lawyer should be able to tell you what law governs your state.
IRS tax collection
Some lenders write off the deficiency and issue a 1099c to the homeowners that shows the amount of deficiency. Form 1099c usually follows a cancellation of debt from the lenders and the borrower needs to report this deficiency loan amount as a taxable income on their Federal income taxes. The Deficiency amount will be considered as an income to the homeowners and they need to pay the appropriate taxes for this income. Homeowners can defend against such a claim (insolvent) by proving that they do not have any income from any source to pay such tax. Under such circumstances, the law gives insolvency exclusion.
Short Sale or HAFA (Home Affordable Foreclosure alternate program):
HAFA is a program initiated by Federal Government to help homeowners avoid the terrible foreclosure process. This program encourages homeowners to short sale their property to keep in from going into foreclosure. This means that the property is sold for less than it is worth but the short sale process helps everyone out. The borrower gets out of the property obligations and salvage his credit and financial future, the buyer gets a good property at below retail price and the bank or lender avoids losings thousands of dollars by preventing the property from going into foreclosure. HAFA is one way to get rid of deficiency judgment. If you foresee foreclosure, please review the HAFA requirement and discuss your options with a qualified real estate attorney.
When all else fails, there is bankruptcy. Under Chapter 7 of the Bankruptcy code, if the borrower files a bankruptcy, all the unsecured loan are written off with few exceptions. Deficiency Judgment is treated as an unsecured loan and in most cases, the record will be removed from your credit report when you file a bankruptcy.
To summarize, if you foresee any possibility of foreclosure, seek a legal advice from a qualified real estate attorney immediately. Although they can be expensive, the cost of not knowing all your rights and responsibilities can be 10 times more costly that obtaining qualified legal representation from the beginning.
There are many government initiated programs available to avoid foreclosure. It is also important that you and your attorney look into those programs and avoid foreclosure. The best way to avoid deficiency judgment is to avoid foreclosure.