Deficiency Judgment after a Short Sale

Deficiency Judgment after a Short Sale

Many people ask if the bank will file a deficiency judgment after a short sale.  It is a great question to ask but the answer is not always clear.  Sometimes deficiency judgments after a short sale pop up unexpectedly because the homeowners did not seek legal or tax advice when performing the short sale.  Every situation is different so it is important to understand what a deficiency judgment after a short sale is.

What is a deficiency judgment after a short sale?

First we should define what a deficiency is.  A deficiency is defined as the difference between the principal balance due and the amount that was received.  If less was received than what was owed, then there is a deficiency.

Next we should define what a judgment is.  A judgment is defined as a public record of the amount owed and by whom.  This would be recorded by the courts.

Lastly we should define what a short sale is.  A short sale is when the bank accepts less money of the amount owed by the seller.  A third party purchases the house at a price that is less than the total loan amount of the previous owner.

So is someone receives a deficiency judgment after a short sale it means that the difference in the amount owed is public record and the person that had the loan can be liable for the difference.

How can the Bank ask for Money after the Property Sells?

A deficiency judgment comes from defaulting on the promissory note, not the mortgage.  A promissory note is a promise to pay the bank a set amount of money.  It is separate from the mortgage so even if the property goes into foreclosure or sells with short sale, the promissory note may still be valid.

That is why it is important to always try to request a full satisfaction or “paid in full” of all liens when performing a short sale so that the bank cannot come after the seller several years later.

What are the 3 Ways that a deficiency judgment after a short sale is handled?

1. The short sale deficiency is waived by all lenders.  The lenders agree to accept less than owed and not pursue the homeowner for a deficiency judgment.

• The seller will receive a 1099 for the amount of debt that was forgiven.  If the seller is financially insolvent, they will likely be exempt from the tax owed if the property was their primary residence.  Talk to a tax professional for more information on this.

2. The lender can request the seller to pay part of the deficiency at closing via cash or an unsecured promissory note.  The promissory note is typically treated like a credit card debt.
3. The lender can refuse to waive the deficiency and require the seller to acknowledge that they will repay the loan as per the original terms.  The bank will typically not require anything from the seller at closing but will retain the right to pursue the debt owed sometime after closing.

What Influences the Lender to seek Deficiency?

The biggest factor that the lender will look at is the financial condition of the seller.  The worse the financial condition of the seller, the less likely the bank will seek a deficiency judgment after the short sale.  The bank will weigh their ability to collect on the amount due vs the amount it costs to attempt collecting.

Another big factor that the lender will look at is if the property is the seller’s primary residence.  The lender is less likely to seek a deficiency on a primary residence.  If there is a second mortgage however, the likelihood of the bank requiring a deficiency note increases especially when the second mortgage is a Home Equity Line of Credit (HELOC).

In Summary:

It is important to work with a team that handles short sales on a regular basis so that the best terms can be negotiated with the bank.  It is important to request a full satisfaction or “paid in full” of all liens when performing a short sale so that the bank cannot come after the seller several years later.  Lastly, always remember to review your situation with a qualified tax professional since every situation is different and unique.

This article should not be construed as legal or tax advice.