Deficiency judgment: What is it and how does it work?

If your lender sells your home through the foreclosure process for less than what you still owe on your mortgage loan, you might still owe money. When this happens, a deficiency judgment may be entered against you in court, giving your lender the right to pursue the amount you still owe.

Whether a foreclosure wipes out your debt depends on the sales price your home fetches when it sells and how much you still owed on your mortgage loan before you stopped making payments.

What is a deficiency judgment in real estate?

If you lose your home to foreclosure and your lender can’t sell it for enough money to cover all that you owe, a court might file a deficiency judgment against you. A deficiency judgment is a legal order that gives your lender the right to pursue the difference between what you owe on your mortgage and the sales price your lender earned when selling your home.

How do deficiency judgments work?

If you stop making payments on your mortgage loan, your lender will eventually begin the foreclosure process. This process allows your lender to take ownership of your home.

If a lender takes possession of your home through foreclosure, it will attempt to sell your home. It will then use the proceeds of your sale to pay off your debt. Sometimes, lenders can’t sell foreclosed homes at a price high enough to cover all the debt that borrowers still owe on their mortgage loans. When that happens, the lender takes a loss on the sale. That loss is known as a deficiency.

If your lender sells your home for less than what you still owed on your loan, a local court might file a legal action known as a deficiency judgment against you. In many states, lenders must first file a lawsuit to get a deficiency judgment. Once a court grants this judgment, though, your lender now gains the legal right to pursue the money you still owe on your mortgage loan.

Deficiency judgment example

Let’s say you owe $150,000 on your mortgage and suffer a loss of income, making you unable to afford your monthly mortgage payments. If you stop making your payments, your lender eventually forecloses on your home and takes ownership of it.

If this were to happen, let’s say your lender sells your home for $130,000. This means the lender has lost $20,000 on the sale because you owed $150,000. If a court files a deficiency judgment against you, your lender can pursue that missing $20,000 from you. Your lender might also seek payment for any additional costs involved in the sale of your home or the foreclosure process.

How do lenders collect deficiency judgments?

Once a deficiency judgment is in place, the court will issue an order for you to pay off your debt. If you ignore the order, lenders have several options for collecting the money. They can collect the money directly from your bank account, put a lien on other property you own or even garnish wages, which is when money is legally withheld from your paycheck.

When do lenders pursue deficiency judgments?

Some lenders won’t pursue a deficiency judgment against borrowers even if they have the legal right to do so. This might depend on how much you owe and whether your lender thinks it is worthwhile to pursue what could be a lengthy and expensive legal action. You can also retain your own legal counsel to fight a deficiency judgment. Again, depending on what you owe, paying your debt might make more financial sense than fighting a deficiency judgment.

If you file for bankruptcy, you might be able to avoid paying what you owe. However, be sure to consult with an attorney before filing for bankruptcy to ensure it’s the best option for your situation.

How long does a deficiency judgment last?

Deficiency judgments spell out how much time a lender has to collect the amount it is owed. This time limit varies by state.

For example, Illinois state law says that lenders have 7 years to collect once a deficiency judgment is enacted. In Maryland, lenders have 12 years to collect their debt on a deficiency judgment, while in Michigan they have 10.

In some states, lenders can petition the courts to extend a deficiency judgment after it expires. A deficiency judgment in Michigan can be extended for another 10 years after the first 10 expire.

A deficiency judgment will remain on your credit report for 7 years. If you apply for a mortgage, car loan, credit card or other loan, lenders will see this negative judgment until it falls off your report. Your credit score will also suffer if a court files a deficiency judgment against you. Your score will already have taken a hit, of course, because of the missed mortgage payments that led to your home’s foreclosure.

What states allow deficiency judgments?

Most states allow deficiency judgments. Only Alaska, California, Minnesota, Montana, Oregon and Washington forbid deficiency judgments in most cases.

Other states only allow deficiency judgments in certain instances. In Arizona, lenders can't purchase deficiencies for one- or two-family homes on 2.5 acres or less. In North Dakota, courts can file deficiency judgments, but usually not for owner-occupied homes.

Judicial foreclosure vs. nonjudicial foreclosure

The foreclosure process can be complicated, and the rules vary by state. But there are generally two types of foreclosures: judicial and nonjudicial.

Judicial foreclosure

In a judicial foreclosure state, lenders must first file a lawsuit in court to foreclose on a property. In a nonjudicial foreclosure state, lenders can start the foreclosure process without going through the courts. All states allow lenders to file a lawsuit to start the foreclosure process, but in states that only allow judicial foreclosure, lenders must file a lawsuit to kickstart the foreclosure process.

In a judicial foreclosure, you are required to file a response – which could be a motion to dismiss the foreclosure – with the court during a specific period, usually within 30 days or fewer. If you don't do this, the lender will typically ask the court to file a default judgment, meaning that the lender wins the case and can begin foreclosure proceedings.

Nonjudicial foreclosure

In a nonjudicial foreclosure, your lender will send you a notice of default, giving you a deadline to begin making your missed payments. You can fight a nonjudicial foreclosure by filing a lawsuit, either on your own or with the help of an attorney.

In states that allow deficiency judgments, courts can file one against you whether your lender completed a judicial or nonjudicial foreclosure against your property.

Deficiency judgment FAQs

For more information on deficiency judgments, check out the answers to some frequently asked questions below.

How can I avoid a deficiency judgment?

If you are able to stop the foreclosure process, you’ll be able to avoid a deficiency judgment. If a foreclosure is unavoidable, a homeowner may be able to negotiate with their lender so that any deficiency is forgiven after the foreclosure is complete. Filing for bankruptcy can also help you avoid a deficiency judgment, but this may not be your best option depending on your financial circumstances.

Can a deficiency judgment be negotiated?

Some lenders may be willing to negotiate with the borrower to waive its right to a deficiency judgment if certain terms are met during the foreclosure process. Discuss your options for avoiding a deficiency judgment with your lender if you’re in this position.

What should I do if I’m dealing with a deficiency judgment?

If you’ve received a deficiency judgment, you may want to consult with an attorney for legal advice. In some cases, it might make more sense financially to pay off the deficiency. In other instances, the deficiency judgment may be worth fighting against.

The bottom line: Know about deficiency judgments if your house is in foreclosure

It’s important to understand how deficiency judgments work if your home is in foreclosure. That’s because your financial challenges might not end with losing your home. Depending on the final sales price of your home, you might still owe thousands of dollars even after your property sells. That’s why it’s so important to research the deficiency judgment laws in your state. And if you want to fight a deficiency judgment, you might need to hire a lawyer who specializes in foreclosure matters.

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.