Deficiency Judgment: What Is It And How Does It Work?

If you've lost your home to foreclosure, you might think you no longer have to worry about your mortgage debt. After all, you've already lost your home. You can now put your foreclosure behind you and concentrate on rebuilding your finances and credit, right?

Not necessarily. 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. 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, then, 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.

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.

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.

Deficiency judgments spell out how much time a lender has to collect the amount it is owed. This time limit varies by state. In Illinois, for instance, 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. In Michigan, for instance, a deficiency judgment can be extended for another 10 years after the first 10 expire.

Lenders don’t always act on a deficiency judgment. If they think the amount owed is too little, they might not act. If you file for bankruptcy, you might be able to avoid paying what you owe.

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.

Here’s how a deficiency judgment could work: Say you owe $150,000 on your mortgage. You might suffer a job loss or some other loss of income and can no longer afford your monthly mortgage payments. You stop making your payments. Eventually, your lender forecloses on your home and takes ownership of it.

Say your lender sells your home for $130,000. This means it has lost $20,000 on the sale because you still owed your lender $150,000. If a court files a deficiency judgment against you, your lender can pursue that missing $20,000. Your lender might also seek payment for any additional costs involved in the sale of your home or the foreclosure process.

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. And 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.

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 30 or fewer days. 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.

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.

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.

It’s important, too, to understand the difference between forbearance and foreclosure. In forbearance, a lender works with you when you are struggling to make your mortgage payments. A lender might temporarily suspend your mortgage payments, for instance, to give you time to overcome financial difficulties. You will, though, have to make up those paused payments.