Deficiency Judgments: Its Meaning and How to Navigate Them
RP
Summary:
Deficiency judgments allow lenders to recover extra money from debtors when the sale of their secured property falls short of paying off the debt. In this detailed tutorial, we’ll delve into the subtleties of deficiency judgments, how they function, their repercussions, and what borrowers may do to protect themselves. We’ll also analyze the advantages and downsides of deficiency rulings and provide a FAQ section to address common issues.
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Understanding deficiency judgments
When a debtor fails on a secured loan and the property sold does not cover the amount, a deficiency judgment is issued. This ruling grants the lender the authority to seek additional payments from the debtor to make up the shortfall.
How a deficiency judgment works
Deficiency judgments can apply to a variety of secured loans, including car loans, where the repossessed property’s sale falls short of the remaining debt owed to the lender. However, the term is most commonly associated with mortgage foreclosures.
Home mortgages are meant to reduce the probability of deficiency judgments. The assessment value of the property generally determines loan amounts, and borrowers frequently need to make an initial payment. These measures reduce the lender’s financial exposure, ensuring that they can recoup their loan if the borrower defaults. However, during real estate market downturns, a property’s value can drop below the outstanding loan amount, resulting in what’s known as an “underwater mortgage.” In such cases, lenders may pursue deficiency judgments.
An example of a deficiency judgment
If you default and the lender seizes your property, the value may not be enough to pay off the loan.
Suppose you owe $500,000 on your property but can’t pay your mortgage. The lender forecloses and sells the property for $450,000. A $50,000 gap remains to repay the $500,000 debt. Deficiency judgments allow your lender to collect the remaining $50,000. The lender may also include foreclosure-related legal fees and other costs in the overall sum.
Note that state deficiency judgment laws do not apply to second mortgages like home equity loans.
How do lenders collect deficiency judgments?
Lenders must follow rigorous criteria for shortfall judgments after house foreclosures in various areas. They typically have to produce comparable listings and professional appraisals to prove the repossessed property sold fairly. The lender cannot accept an excessively low offer and then demand the rest from the borrower.
Even in states that allow deficit judgments, they are not usually issued. The lender must file a motion to get one. If the lender does not request this, the court may determine that foreclosure auction proceeds are sufficient, preventing a shortfall judgment.
After winning a deficiency judgment, a lender may use different collection methods to recover the debt. This could involve liens on the debtor’s other assets, garnishing their wages, or freezing their bank account.
What to do when facing a deficiency judgment
Debtors who receive a deficiency judgment have several options to consider. They may seek exemptions from the lender or other creditors, file a motion to have the judgment overturned, or, if necessary, declare bankruptcy.
The Internal Revenue Service (IRS) considers forgiven debt from deficiency judgments income and may tax it; however, there may be exceptions.
Deficiency judgments and short sales
After a short sale, most states allow for deficiency judgments. A short sale occurs when a bank agrees to enable a borrower to sell a property for less than the amount owed on the loan. This is common in deteriorating real estate markets when banks want to reduce their losses through quick sales rather than foreclosure. Borrowers may benefit from the conclusion, depending on their own circumstances.
Furthermore, deficiency judgments are often accepted in an agreement known as “deed in lieu of foreclosure.” In this arrangement, the bank acquires title to the property instead of proceeding with a foreclosure.
If my lender gets a deficiency judgment against me, what can they do to collect it?
If a lender obtains a deficiency judgment against a debtor, they may employ different methods to collect the owed funds. This can include garnishing the debtor’s wages, placing liens on the debtor’s other properties, or seizing funds from the debtor’s bank account. The specific collection procedures can vary from state to state, so it’s essential for debtors to understand their rights and options in their jurisdiction.
How can I protect myself against a deficiency judgment?
Debtors facing the prospect of a deficiency judgment have several potential avenues to protect themselves. They can explore options such as negotiating alternative repayment arrangements with the lender or challenging the deficiency judgment in court. However, it’s crucial to note that personal bankruptcy is another alternative, though it comes with long-term consequences and should be considered carefully, weighing both its pros and cons.
Frequently asked questions
Are deficiency judgments only related to mortgage foreclosures?
Deficiency judgments are usually linked with mortgage foreclosures, but they can apply to any secured loan if the repossessed property falls short of paying off the debt. This includes car loans.
What are the tax implications of a deficiency judgment?
When a debtor’s forgiven debt results from a deficiency judgment, it is considered income by the Internal Revenue Service (IRS). This means that debtors may be subject to taxation on the forgiven amount, though specific exceptions can apply based on individual circumstances and tax laws.
Can deficiency judgments be challenged or overturned in court?
Yes, debtors who receive deficiency judgments have the option to file motions challenging or overturning the judgment in court. The success of such efforts will depend on a variety of factors, including the specific circumstances of the case and applicable state laws.
What are the long-term consequences of personal bankruptcy as a response to a deficiency judgment?
Declaring personal bankruptcy as a response to a deficiency judgment can have significant long-term consequences for a debtor’s financial standing. It can impact credit scores, limit access to credit in the future, and result in numerous legal and financial ramifications. Debtors should carefully weigh the pros and cons before pursuing this option.
Key takeaways
- Deficiency judgments allow lenders to collect more money from debtors when the sale of their secured property falls short of paying off the debt.
- Deficiency judgments are most common after mortgage foreclosures, although they are not allowed in every state.
- Debtors facing deficiency judgments can explore options such as negotiating alternative repayment arrangements, challenging the judgment in court, or considering personal bankruptcy with awareness of its long-term consequences.
- Forgiven debt resulting from deficiency judgments is considered income by the IRS and may be subject to taxation, with specific exceptions depending on the situation.
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