Deficiency judgments often follow a mortgage foreclosure, leaving the former homeowners on the hook for thousands or even tens of thousands of dollars. Sometimes, because of the common misconception that the sheriff’s sale eliminates the homeowner’s entire liability for the loan, the deficiency judgment comes as a complete surprise to the debtor. Fortunately, it is possible to avoid, eliminate, or at least reduce deficiency judgments by strategic use of Chapter 7 and Chapter 13 bankruptcy and non-bankruptcy remedies, such as mortgage foreclosure defense.
What is a deficiency judgment? A “deficiency” and a “deficiency judgment” are two separate but related things. A deficiency occurs in a mortgage foreclosure when the amount obtained at the sheriff’s sale is less than the mortgage balance. A “deficiency judgment” is an order by a court making the debtor personally responsible for the shortfall that occurs when the property is sold in foreclosure for less than the balance owed to the mortgage lender.
Example: John and Karen owe $175,000 on their home mortgage loan. The home goes into foreclosure and is sold at the sheriff’s sale for $165,000. There is a deficiency of $10,000, because the house sold for $10,000 less than the balance on the mortgage loan.
A deficiency is essentially unenforceable, unless the bank reduces this debt to judgment. In order to obtain deficiency judgment, the mortgage lender must file a separate lawsuit or “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 and, most likely, some attorney’s fees and costs.
Example: Let’s look again at John and Karen from the above example. Their house sold at sheriff’s sale for $10,000 less than they owed to the bank, leaving a $10,000 deficiency. The lender wants to collect this deficiency. Therefore, after the sale, the lender files a separate lawsuit seeking a deficiency judgment against John and Karen for $10,000. If the court agrees with the lender, it will issue a deficiency judgment for $10,000, making John and Karen personally responsible for the debt.
How may a lender enforce a deficiency judgment? A lender may attempt to collect on a deficiency judgment in the same way it might collect any other judgment, including levying bank accounts and personal property. In Pennsylvania, this judgment can be renewed every five years for twenty years, giving the lender a fair amount of time to collect. During this period, the judgment can accumulate interest at the post-judgment rate.
Quick Note: The potential for a deficiency judgment is the main reason that it is not necessarily a good idea to just walk away from a mortgage loan without consulting a bankruptcy lawyer or mortgage defense attorney.
What are the limits on deficiency judgments in Pennsylvania? First, a creditor must file an action for a deficiency judgment within six months of the sheriff’s sale. 42 Pa. Con. St. Ann. § 5522(b)(2). If the lender fails to do so, it cannot obtain a deficiency judgment, and the debt is unenforceable.
Example: The bank forecloses on Barbara’s home, and the house is sold at the Sheriff’s sale on June 1, 2012. As a result of the sale, there is a deficiency of $25,000. The bank has until December 1, 2012 to file a deficiency action. If it does not, it cannot obtain a deficiency judgment, and the $25,000 deficiency is unenforceable.
Second, if the lender purchases the property at the sheriff’s sale, the deficiency judgment is limited by the fair market value of the house. 42 Pa. Con. St. Ann. § 8103(a).
Example: If the Ann and Tom’s mortgage balance is $100,000, and the lender bids $75,000 on a home worth $100,000, the deficiency would be $25,000. However, if the home is worth only $80,000, the deficiency judgment is limited to $5,000, which is the difference between what the bank bid and the fair market value of the house.
What can a debtor do to limit or eliminate a deficiency judgment during or after a foreclosure?
–Negotiate a settlement with the mortgage company. Deficiency judgments are negotiable, both during and after a foreclosure. Sometimes is it is possible to negotiate with the bank to obtain either the complete waiver of a deficiency or a settlement for far less than the balance of the deficiency. Often a settlement can be reached with the bank during a mortgage foreclosure defense, perhaps even a “cash for keys” settlement in which the bank pays you to vacate property.
–Negotiate a deed in lieu of foreclosure or a short sale. Banks will sometimes accept a deed in lieu of foreclosure, which eliminates the possibility of a deficiency in exchange for signing the home over to the bank. Similarly, a short sale, in which the bank accepts a sale at less than the balance owed, can help you avoid a deficiency. Both of these options can be difficult and take some persistence.
Quick Note: If you are considering a deed-in-lieu or short sale, it is important for an attorney to review the documents. If the documents do not specifically state that you are not liable for any deficiency, it is still possible for the bank to seek a deficiency judgment. As a bankruptcy attorney in greater Philadelphia, I have seen a number of questionable deeds-in-lieu and short sale approval letters over the years.
–Challenge the valuation. If the bank has already filed a deficiency action, the debtor can challenge the lender’s claimed fair market value of the home. If you can show that the actual fair market value of the house is less than the lender claims, you can reduce or possibly eliminate the deficiency. However, you should seek the counsel of a foreclosure defense attorney and keep an eye on the response dates.
–File for bankruptcy. Bankruptcy discharges deficiency judgments. Deficiency judgments are fully dischargeable in Chapter 7 and either fully or partially dischargeable in Chapter 13 bankruptcy. If you are facing a deficiency judgment, bankruptcy can be a good option.
You need not wait until you are hit with a deficiency judgment to consider bankruptcy. Chapter 13 bankruptcy may help you stay in your home, if you file before it reaches the sheriff’s sale. The earlier you seek help, the better. However, even if the sheriff’s sale date has been set, it may not be too late. The same applies to foreclosure defense, although you would not want to wait to the eleventh hour, if at all possible. It is certainly worth a free consultation with a bankruptcy attorney to explore your options.