Deficiency judgment: What it is and why it matters after foreclosure

A deficiency judgment is a court order requiring a borrower to pay the remaining balance of their mortgage debt if their home did not recover the full loan balance at foreclosure sale. It isn’t automatic, and it isn’t allowed in every state. Learn what a deficiency judgment is, when it can happen, how it may affect your finances, and the steps you can take to reduce or avoid it.

What is a deficiency judgment in real estate?

In real estate, a deficiency judgment is when a court requires you to pay the balance on your mortgage if your home was sold at foreclosure for less than you owe.

While deficiency judgments are commonly associated with mortgage foreclosures, the concept can apply to other types of secured loans.

Keep in mind that whether a deficiency judgment is allowed depends on state foreclosure law and the type of foreclosure. For instance, some states allow deficiency judgments only when the lender can prove the property was sold at a fair price.

Why lenders may or may not pursue a deficiency judgment

When weighing whether to pursue a deficiency judgment, lenders may consider the size of the deficiency, the borrower’s income and assets, the legal cost, the time required to pursue it, and state law. Ultimately, a deficiency judgment is a business decision, not a requirement.

How a deficiency judgment can affect you financially

A deficiency judgment can turn your unpaid mortgage balance into an immediate financial obligation. Your mortgage lender will try to collect on the debt, which may result in your wages being garnished or bank accounts being levied.

While the judgment itself may not appear on your credit report, the circumstances leading up to the judgment – missed mortgage payments, foreclosure – likely will already have reduced your credit score and make it difficult for you to rent a place to live or apply successfully for credit of any kind.

These are only potential risks, not guaranteed outcomes.

How to reduce or avoid a deficiency judgment

Reducing or avoiding a deficiency judgment requires acting promptly and communicating with your lender. After all, foreclosure can be an expensive and drawn-out process for them as well, so they may be willing to negotiate a way to avoid it altogether.

Potential loss mitigation strategies include a short sale, where the lender agrees to let you sell your home for less than you owe on the mortgage. Some jurisdictions allow a deed in lieu of foreclosure, where you voluntarily turn over ownership of your home to the lender to avoid foreclosure.

What to do if you’re facing a deficiency judgment

If you’re facing a deficiency judgment, don’t panic. Instead, carefully review court documents, familiarize yourself with your state-specific rules, and seek reputable housing or legal guidance if needed.

How deficiency judgments work

There are three steps to the deficiency judgment process.

Step 1: Foreclosure or property sale

Foreclosure is the legal process by which a lender takes possession of a property after a borrower defaults on the mortgage. Once seized, the property typically is sold at a public auction or through another legally defined process.

A deficiency judgment can only occur if the sale of the property fails to fully compensate the lender for its losses.

Step 2: Calculating the deficiency

To calculate deficiencies, lenders compare the sale proceeds to the remaining loan balance.

For example, imagine your outstanding mortgage balance at the time of foreclosure is $250,000. The property then sells for $220,000 at a foreclosure sale. The difference between these two figures is $30,000, resulting in a deficiency.

That said, this example is illustrative only. Real-world outcomes depend on state law, the foreclosure process used, and the lender. Furthermore, depending on state law, the deficiency calculation may or may not include fees, interest, and other foreclosure-related costs.

Step 3: Court involvement and lender action

Next, lenders must request a deficiency judgment from the local court. Before granting a deficiency judgment, the court may review whether the sale price was fair, per state law. In some cases, a lender may choose not to pursue a deficiency even when legally permitted to do so.

Can deficiency judgments be negotiated or settled?

Yes, lenders may be willing to negotiate repayment or settlement terms. If so, get the agreement in writing to protect your legal rights, and remember that outcomes vary widely by lender and state law.

How lenders collect deficiency judgments

Once granted, a deficiency judgment can be enforced like any other court judgment, including wage garnishment, bank account levies, or a lien on other property. State laws may limit collection methods, and many lenders don’t pursue aggressive collection.

Why lenders may or may not pursue a deficiency judgment

When weighing whether to pursue a deficiency judgment, lenders may consider the size of the deficiency, the borrower’s income and assets, the legal cost, the time required to pursue it, and state law. Ultimately, a deficiency judgment is a business decision, not a requirement.

How long does a deficiency judgment last?

Deficiency judgments typically remain enforceable for years, depending on state law. In some states, the judgment can be renewed once it has expired. Research your state's rules on the duration limits of deficiency judgments for better long-term financial planning.

What states allow deficiency judgments?

State laws vary widely on whether deficiency judgments are allowed, limited, or prohibited.

For example, some states only allow deficiency judgments if the court confirms the foreclosure sale or if it’s over a non-owner-occupied home. Others allow deficiency judgments with fewer exceptions, and some prohibit them altogether. Confirm the rules in your state by consulting a legal professional or other authoritative source.

Judicial vs. nonjudicial foreclosure: Why the difference matters

The possibility of a deficiency judgment also can depend on whether it’s a judicial or nonjudicial foreclosure.

Judicial foreclosure

Judicial foreclosure means a lender must go through the court system to foreclose on a home, and a judge oversees the case. Since the court is already involved, lenders in judicial foreclosure states are often legally permitted to ask for a deficiency judgment, depending on state law.

Additionally, judicial foreclosure typically includes formal steps, such as hearings and court approval of the sale, which can make it easier for a lender to request additional relief, such as a deficiency judgment.

As a homeowner, this means judicial foreclosure can increase the likelihood that a lender will pursue a deficiency judgment, since the legal pathway already exists. As a result, you may face greater post-foreclosure financial risk in a judicial foreclosure state.

Nonjudicial foreclosure

Nonjudicial foreclosure means a lender doesn’t need court approval to foreclose on a home, so long as they follow procedures laid out in the mortgage agreement and state law.

Because nonjudicial foreclosure avoids the court system, many states limit or prohibit lenders from pursuing a deficiency judgment afterward. This is often designed to balance the speed and efficiency lenders gain from nonjudicial foreclosure with protection for homeowners.

For instance, choosing a nonjudicial foreclosure may mean a lender gives up the right to pursue a deficiency judgment in some states. This can significantly reduce your financial risk after foreclosure, even if the home sells for less than the loan balance.

FAQ

Here are answers to common questions about deficiency judgments.

Can a deficiency judgment affect my credit?

A deficiency judgment itself doesn’t directly affect your credit, but it can if it leads to collection activity. Additionally, missed payments, foreclosure, and any unpaid judgment-related collections may already be reflected on your credit report.

Do deficiency judgments apply after a short sale?

It depends on state law and the terms of the short sale agreement. In some states, lenders are prohibited from pursuing a deficiency judgment after a short sale. In others, they may still be allowed to if they haven’t explicitly waived their right to pursue one. That’s why it’s important to get written confirmation on whether the remaining loan balance is forgiven.

Can a deficiency judgment be discharged in bankruptcy?

A deficiency judgment may be treated as unsecured debt in bankruptcy and be discharged, depending on the situation. Bankruptcy outcomes vary based on the type of bankruptcy filed and individual circumstances. Seek qualified legal counsel on whether to consider bankruptcy.

The bottom line: Understanding deficiency judgments helps you plan ahead

Ultimately, deficiency judgments are situational, not inevitable. Now that you know how they work, you can make more informed financial decisions should you ever face one.

If you’re concerned about a deficiency judgment because you’re entering the preforeclosure process, learn about what preforeclosure entails, and what you can do to avoid foreclosing on your home.