Deficiency judgments often follow a mortgage foreclosure, leaving the former homeowners responsible for thousands or even tens of thousands of dollars of debt. A “deficiency judgment” is an order by a court making the debtor personally responsible for the shortage that occurs when the property is sold in foreclosure (sheriff’s sale) for less than the balance owed on the mortgage. There is a common misconception that the sheriff’s sale eliminates the homeowner’s entire liability for the loan so a deficiency judgment is often a complete surprise to the debtor.
What Is a Deficiency After Foreclosure?
When a lender forecloses on a mortgage, the total debt owed by the borrower to the lender is often more than the foreclosure sale price. The difference between the sale price and the total debt is called a “deficiency,”
Example: Say the total debt owed is $200,000, but the home only sells for $150,000 at the foreclosure sale. The deficiency is $50,000.
How does a lender obtain a deficiency judgment?
In order to collect this deficiency, the mortgage lender must file a petition to fix fair market value (a “deficiency action”) against the debtor. If the lender prevails, the court will issue a judgment in favor of the lender for the amount of the deficiency. Deficiency judgments accumulate interest at the post-judgment rate of 6%.
How does a lender enforce a deficiency judgment?
A lender can collect on a deficiency judgment in the same way it would collect any other judgment. In Pennsylvania, the judgment lender has 20 years to collect against personal property, including bank accounts, household items, etc. (Although the judgment lender must renew the judgment every 5 years).
The judgment lender can also obtain a lien on the debtor’s other real property in the county where the judgment was entered. Judgments can also be transferred between counties. So a deficiency judgment can be a very serious problem, particularly if the debtor owns real property in addition to the property in foreclosure. The potential for a deficiency judgment is one reason that it is usually not a good idea to just walk away from a mortgage loan without consulting a bankruptcy or mortgage defense attorney.
Are there limits on deficiency judgments in Pennsylvania?
As with most other civil judgments, there are important limitations to collecting deficiency judgments in Pennsylvania. For example, wage garnishment is not permitted in Pennsylvania for deficiency judgments. In addition, if the judgment is against one spouse only, the creditor cannot collect against the joint marital property, including other real property and money in joint bank accounts.
What happens to any second mortgage or line of credit?
Generally, only a first mortgage holder will seek a deficiency judgment in Pennsylvania. There is no need for a lender holding a second mortgage to obtain a deficiency judgment because any unpaid balance on the second mortgage becomes an unsecured loan upon the sale of the house at the sheriff’s sale. The second mortgage holder can sue the debtor and obtain a judgment but must do so within the four-year period set by the Pennsylvania Statute of Limitations.
What can a debtor do to avoid a deficiency judgment during or after a foreclosure?
There are several options for dealing with deficiency judgments. The most common are listed below.
Negotiate a deed in lieu of foreclosure or a short sale.
One of the alternatives to foreclosure is a “deed in lieu of foreclosure.” Simply stated, this means that rather than making the lender go through the foreclosure process, the homeowner agrees to execute a deed for the property transferring it to the lender. In return, the lender agrees to accept the deed (and transfer of title) and not go through with a foreclosure sale. In theory, a deed in lieu of foreclosure seems like a good alternative for homeowners who have decided to give up the property and it saves the lender the time and expense of a foreclosure sale and the risk that the homeowner may file a Bankruptcy case to stop the foreclosure. However, in reality, it rarely works out well for homeowners. Simply deeding the property back to the lender does not absolve the homeowner from a deficiency claim by the lender. On the contrary, the lender may sell the house for far less than market value and the homeowner will get a large bill (or lawsuit) for the balance of the debt. Any deed in lieu of foreclosure should be part of a larger settlement agreement with the lender either waiving a deficiency or agreeing to a firm settlement amount the homeowner can afford to pay. Additionally, if the lender takes a loss and writes off all or part of the debt, they will issue a 1099 for the “forgiven” debt which means the homeowner may have a tax liability for the forgiven debt, which is treated as income.
How does a short sale work?
In a short sale, the homeowner arranges with their mortgage lender to accept a price that’s less than the amount they owe on the property. As part of this arrangement, the lender typically agrees to forgive the rest of the loan. As a result, the seller doesn’t have to go through a foreclosure and the lender avoids assuming the burden of unloading the property. Generally, lenders will only agree to a short sale if the homeowner is many payments behind and has received a default notice. As with a deed in lieu of foreclosure, there can be tax consequences for the homeowner in a short sale. For example, if you owe $300,000 to your mortgage lender and short sale the home for $250,000, the homeowner may have a tax liability for the forgiven $50,000 of debt. Any loss to the lender/creditor is treated by the IRS as income to the homeowner.
Both of these options can be difficult, time-consuming, and will take some persistence. If you are considering a deed in lieu of foreclosure or a short sale, it is important to have an attorney review the documents as to both options.
File for Chapter 7 bankruptcy.
A Chapter 7 bankruptcy discharge prevents the owner of the note and mortgage on the property from seeking any additional payment from the property owner. The discharge effectively releases your legal obligation to repay money to the mortgage company. This would apply to any bankruptcy filed prior to the completion of the foreclosure and may be used after foreclosure if the bank seeks a deficiency. Also, if a deficiency judgment attaches to real property that is exempt from bankruptcy, it may be possible to avoid (remove) the lien. Additionally, a Chapter 7 discharge avoids personal income tax liabilities that may have resulted from a Short Sale or Deed in Lieu of Foreclosure.
Note: In Chapter 7 bankruptcy, debtors who are current on their mortgages have the option of continuing to pay on the mortgage without reaffirming the debt. If you do not reaffirm the debt but cannot pay the mortgage later on (even years after your discharge), the lender cannot obtain a deficiency judgment. However, if you reaffirm the mortgage debt in bankruptcy, the lender can obtain a deficiency. There are also other benefits to not reaffirming debts in bankruptcy.
File for Chapter 13 bankruptcy.
A Chapter 13 bankruptcy is a payment arrangement whereby you pay back a portion of your debts over 36 to 60 months. Any remaining unsecured debt (with a few exceptions), including a mortgage deficiency, is discharged after your final payment. As with Chapter 7, a Chapter 13 debtor may avoid a lien arising from a deficiency judgment that attaches to exempt property.
Note: You need not wait until you are hit with a deficiency judgment to consider bankruptcy. A Chapter 13 bankruptcy may help you stay in your home if you file before it reaches the sheriff’s sale. Even if the sheriff’s sale date has been set, it may not be too late. However, the earlier you seek help, the better. The same applies to mortgage foreclosure defense.
Defend the mortgage foreclosure action.
Sometimes, you can challenge the foreclosure before it gets to a sheriff’s sale. Mortgage foreclosure defense gives debtors the opportunity to defend against the foreclosure action. In some cases, it is possible to reach a settlement with the lender to modify the mortgage.
Know Your Options.
The key to dealing with a deficiency judgment or a potential deficiency judgment is information. Know your options, so you can protect your assets and avoid unnecessary financial damage. It is definitely worth a free consultation with a bankruptcy attorney to explore your options.
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