Tricky Short Sale Deficiency Judgments
By Attorney Ginger Kelly
Agreeing to a short sale may seem like the best way to avoid foreclosure in many situations, but what happens to the money owed, after the short sale?
Quite often homeowners think short sales are the perfect solution to a difficult situation, the silver bullet, so to speak. The bank agrees to accept a sale price for less than the mortgage amount and presto, foreclosure averted! But the problem with this is, a year or so after a short sale is completed, the mortgage lender can (and often will) seek a deficiency judgment against the former homeowner.
What is a Short Sale?
A short sale is when you sell your home for less than the total debt balance remaining on the mortgage. The sale price is “short” of the full debt amount. The short sale process involves the mortgage lender agreeing to accept the sale proceeds and release the lien on the property and then, the proceeds of the sale pay off a portion of the mortgage balance. Short sales are one way for borrowers to avoid foreclosure.
What is a Deficiency Judgment?
A deficiency is when a foreclosure sale doesn’t produce enough funds to pay the mortgage debt in full. The amount of the deficiency is the difference between the amount of the mortgage debt and the foreclosure sale price. A deficiency judgment is a judgment that the lender may obtain from a Judge, giving the lender the right to collect the deficiency from the borrower.
In a short sale situation, for example, if a homeowner sells their home in a short sale for $200,000, and the amount owed on the mortgage was $250,000, then $50,000 would be the deficiency amount. The lender could get a judgment from a Court Judge for the amount left owing and then some. This includes not only the $50,000 deficiency, but interest, other costs and sometimes attorney’s fees.
Deficiency Judgments in Massachusetts and Why are They So “Tricky?”
Massachusetts is one of those states where a lender is permitted to seek a personal judgment against a borrower after a short sale to recover the deficiency amount. The tricky part comes in when, in general, once the lender gets a deficiency judgment against a borrower, the lender may collect this amount by using things such as a wage garnishment, bank account levy or by placing liens on titled property, like automobiles and motorcycles.
In Massachusetts, after a short sale, the lender can choose to do one of the following two things about the deficiency:
- The lender may choose to forgive the deficiency amount and issue to the borrower a Form 1099-C (Cancellation of Debt), which reports the deficiency as taxable income to the IRS. If this happens, the borrower (former homeowner) will have to pay taxes on the additional income this brings in the year they receive the 1099-C. For most people, who were struggling to pay their mortgage, this causes tremendous hardship.
- The lender may choose not to forgive that part of the debt that has not been covered by the sales price and keep the right to file a court action to obtain a deficiency judgment.
If you are a homeowner and are thinking about negotiating a short sale with your mortgage lender in Massachusetts, it is very important to negotiate with your lender before you agree to a sale, to have the deficiency forgiven.
How Can I Avoid a Deficiency Judgment Following a Short Sale?
There are at least four ways to avoid having to pay back the deficiency.
- Negotiate a Waiver of the Lender’s Right to Seek a Deficiency Judgment
When a homeowner finds it necessary to sell their home in a short sale, it is important to try to negotiate with the mortgage lender and ask them to approve not only the short sale, but to a waiver of the right to seek a deficiency judgment. If your lender agrees, this provision must be included in the short sale agreement. That means, always get the waiver in writing. The short sale agreement must expressly state that the transaction is in full satisfaction of the debt and/or that the lender waives its right to the deficiency.
- Make a Settlement Offer
The second option homeowners have is, if the mortgage lender does not agree to waive the deficiency, the homeowner can offer to settle the deficiency for a smaller amount. Many lenders agree to accept a smaller amount because collecting a deficiency is expensive and typically takes a long period of time. It’s easier for lenders to accept a reduced lump sum, rather than going through the expensive and lengthy legal process to try to collect. A homeowner can also negotiate to repay the reduced deficiency debt in installments, over time.
- Hope the Lender Won’t Sue for the Deficiency
If the homeowner was not successful in negotiating a waiver of deficiency or a reduced deficiency payment plan, the mortgage lender will likely call and send collection letters stating that the deficiency amount is owed. Collection letters typically come from a lawyer’s office or a collection agency. However, without taking the homeowner (borrower) to court and getting an actual deficiency judgment, the lender cannot levy any bank accounts, garnish wages, or place judgment liens on other property the borrower may own.
To get a deficiency judgment, the lender must file an expensive lawsuit. Many borrowers, who are forced to complete a short sale of their homes to avoid a foreclosure, are judgment proof. This means that they don’t have much money, wages or other property (assets) that a creditor can take to pay off the judgment. If a borrower can’t afford to pay the deficiency, there is a possibility that a mortgage lender won’t even bother filing a lawsuit against them.
- Declare Bankruptcy
The other possibility is to file for bankruptcy to eliminate the debt. A Chapter 7 bankruptcy would totally discharge the deficiency relieving the borrower of the entire debt. A Chapter 13 bankruptcy will require a payment plan for 3 or 5 years to pay a portion of the total amount owed. Bankruptcy may also be the most pro-active way to alleviate the tax problem before the lender issues a 1099-C. Income taxes are not typically discharged in Bankruptcy unless they are very old and a borrower can’t retroactively discharge a recent 1099-C tax debt.
On the other hand, if taxes or the deficiency are all the borrower owes, bankruptcy may not be the best option. However, Bankruptcy may be something to consider when the borrower is facing a lot of debt they can’t pay, or when a borrower needs to eliminate the possibility facing a tax burden they simply can not afford to pay in the future. To find out more about whether or not Bankruptcy is really the easy way out, click here.
September 14, 2017
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ABOUT ME: Attorney Kelly is an attorney in good standing, licensed to practice in both the Federal District and State Courts of Massachusetts and Rhode Island. Her law practice is focused on consumer debt, finance, bankruptcy and District Court matters. Attorney Kelly is experienced in both criminal and civil trial work. On a personal note, Attorney Kelly enjoys writing and other things, like conservation and agriculture.
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