A Deficiency Judgment after Foreclosure vs. After a Short Sale

 
Once a lender completes a foreclosure sale to recover their money through the sale of the collateral property, a homeowner may have liability for difference between the amount of money owed and what the lender was able to recover through the sale. The lender will then have a couple of options to recover that money assuming it was a guaranteed loan: 1) Write off the loss as a business loss by filing a 1099 at the end of the year, or 2) Filing a deficiency judgment in the amount of the shortfall. From working with previous clients, a lender generally will not go after a deficiency by suing former homeowners after the foreclosure sale, unless they believe that the homeowner has the assets to cover the amount of the judgment.  However, in the event that the lender is aware that the foreclosure victim has a lot of liquid assets and went into foreclosure just to avoid paying bills, it is more likely. Obviously, this is a rare occurrence, and in most cases it is in the bank’s best interest to just write off the loss following the foreclosure sale. As a general rule of thumb, if there is little chance of recovering any money, the banks do not want to act as a collection agency or pay someone else to do so.

If homeowners sell their property through a short sale, where the bank takes less than the total amount owed on the mortgage, it is possible to get the bank to agree to absolve a homeowner of all future liability for the short fall. For many of our clients, the lenders have agreed that the loan is “paid in full” for less than the full amount.  The lender forgives the remaining amount of the debt that is not paid through the short sale, and cannot sue for debt it has forgiven. However, homeowners may have to pay taxes on the amount forgiven since the IRS considers this to be income if a lender files a 1099 to write off their loss.

One of the greatest advantages to the homeowner of working a short sale versus allowing your house to go to foreclosure is that in a short sale, you have the opportunity to negotiate the terms of acceptance and liability with your lender. In a short sale, you can fight to limit your liability instead of accepting whatever the lender wants to give you in a foreclosure.

Homeowners should consult with a tax adviser or check the tax laws for exemptions because often times there are ways around paying these taxes and there are protections for homeowners in foreclosure.