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How a Deficiency Balance Can Affect You

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Updated: Sep 23, 2014

Highlights

  • Understand what a deficiency balance is.
  • Review what may make you responsible for a deficiency balance.
  • Examine the potential tax implications that come with a forgiven debt.
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Some lenders may forgive a deficiency balance on a mortgage, but not all do.

Even after closing out your loan with your lender, through either a short sale, deed-in-lieu of foreclosure, or a foreclosure, your problems may not be behind you. Depending on the original terms of your loan as well as the state you live in, you may end up with a significant financial liability or a tax liability. You may owe your former lender(s) if the sale proceeds did not pay the entire balance you owed on all loans that were secured by your property. The difference between what you owed and what the home sold for is called a deficiency balance.

Some lenders may forgive a deficiency balance, but not all do. It is often an unsound economic decision for a lender to sue you for the deficiency balance. For one, you may not have any resources to pay them. You likely would not have defaulted on your mortgage if you could have afforded to pay it.

Some states protect their citizens with anti-deficiency laws. Rules vary from state to state.

Non-Recourse or Recourse Loan

An important factor in whether you can be liable for a deficiency balance is whether your loan is a non-recourse loan or a recourse loan. A non-recourse loan restricts your lender’s ability to collect on your defaulted loan to the assets used to secure the loan. For your mortgage loan, it is likely that the home itself was the only security. If you have a non-recourse loan and your lender forecloses on you, then it cannot get a deficiency judgment and attempt to collect on it. It can only sell the home and keep the proceeds.

Most non-recourse loans are restricted to loans used to purchase a primary residence. If your lender foreclosed on your investment property or vacation home, you likely are liable for the deficiency balance. You could also be liable for the deficiency balance if you had taken out a loan on a primary residence and the home was no longer your primary residence.

A recourse loan is one where the lender has the legal means to collect the deficiency balance from you. Your lender can pursue collections, including suing you to get a deficiency judgment against you, which can lead to a levy on your wages. Your lender can also sell or assign the debt to a collection agency that can come after you to collect on the debt. Your lender may or may not decide to pursue collections, if it has the legal authority to do so. There is no sure way for you to know. Lenders realize that if you went through a foreclosure or short sale that you may have a severe financial hardship which makes collecting on the debt difficult. If your lender takes the time, expense, and effort to get a judgment against you, it may never be able to collect. Therefore, it may not even pursue collecting in the first place.

Some states are non-recourse states, while other states are recourse states. In non-recourse states, your lender generally cannot come after you for any balance that remains after the proceeds from the sale of your primary residence home are applied to your outstanding mortgage debt. Still, even within non-recourse states, things are not black and white. Loans that were not used for purchase money can become a recourse loan even in a non-recourse state. Check the terms of your loan. In fact, it is a good idea to know whether your loan will be a recourse or non-recourse loan, before you take out the loan.

Tax Implications

In some cases, you lender my write of the debt, deciding instead of trying to collect it from you. A debt that your lender wrote off can result in a tax liability for you. A 1099-C is a notice to the IRS that the financial institution has forgiven or canceled a debt of $600 or more. If the financial institution issues a 1099-C to you, then it has forgiven the debt and you must report the dollar amount shown on the 1099-C as income on your income tax return. Fortunately, the Mortgage Forgiveness Debt Relief Act of 2007 allows taxpayers to exclude income from the discharge of debt on their principal residence. The forgiveness is restricted to mortgage debt that you incurred to purchase your home. If you took out cash from the equity in your home in a refinance, as many Americans did during the real estate boom period, you are not covered by the Mortgage Forgiveness Act. Even if you cannot use the protections of the federal act, you may still be able to avoid declaring the dollars listed on the 1099-C. Check with a CPA, tax attorney, or tax professional to see if you meet the IRS rules regarding your assets and liabilities and can use the IRS Form 982 to avoid declaring the 1099-C as income.

If the financial institution issues a 1099-C to you, it will probably not pursue you for the deficiency balance because it has deducted the loss on the loan from its taxes. However, there is no guarantee the financial institution will not pursue you for the deficiency balance and then later amend its tax returns.

Negotiate

Consider negotiating with your creditor in an attempt to reach an out-of-court settlement on the debt. The good news here is collection agents purchase deficiency balance collection accounts for 1 or 2 cents on the dollar. (This is in contrast to credit card collection accounts, where the industry standard is 6 or 7 cents on the dollar. If necessary, enroll the debt in a debt negotiation program. (Go to the Bills.com debt relief savings center for a no-cost quote.) Another option is to negotiate the debt yourself. Consider opening negotiations at 5 cents on the dollar for a lump-sum settlement. This amount may sound small, but given the fact the collection agent bought the collection account for a penny or two on the dollar, this amount gives the collection agent a handsome return on their investment.

Summary

If a creditor pursues you for a deficiency balance, make sure you understand which financial and tax responsibilities can follow you, even after you lose or sell your home. Speak with an attorney or a tax specialist to your rights and liabilities under your state's laws. The last thing you want is for a problem you thought was behind you to rear its head with IRS collection notices or a wage levy from a judgment an aggressive creditor obtained.

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81 Comments

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  • TT
    Apr, 2014
    Thomas
    I have a credit issue from a long past junior lien mortgage that I opened in 2004 along with a first mortgage. The junior lien was a purchase money home equity fixed 20 year mortgage (I secured an 80/20 loan when I purchased the home). In 2007, my house was foreclosed at sheriffs sale after a 6 month redemption period, state of MN. The house was auctioned at about $150,000 so there wasn't enough to nearly payoff the 1st lender much less the 2nd (The EMV at the time of sheriff sale was about $230,000 and I owed 200k on 1st and 55k 2nd). MN is a non recourse state, so I thought that both the first and second mortgage would "go away" after sheriff sale. Finally about a year ago the 1st lien foreclosure on my credit report fell off my credit report with all 3 credit bureaus, however this 2nd lien still reports to all 3 bureaus (as a charge-off with $27,000 past due). Keep in mind that the property this second mortgage was attached to, foreclosed in Feb 2007 (over 7 years ago) What happened is that the OL continued to report this "mortgage" to the CB's until 2010, then they sold it off to a 3rd party debt collection agency. All 3 CB's show that the last reported payment from me was in 2010 but that's B.S., the last payment I made was in 2006 which was when foreclosure process began. Is it prudent for me to file disputes with the CB's or do I wait until 2017 when this negative acct is schdld to stop reporting to CB's? Scared to open a can of worms by disputing!
    0 Votes

    • BA
      Apr, 2014
      Bill
      If you are certain you would not have to pay the debt due to its non-recourse status or due to being able to claim the SOL as defense were you sued, then I see no can of worms to worry about. Dispute the debts with all CBs reporting them.
      0 Votes

  • SB
    Apr, 2014
    scott
    If someone has a mortgage deficiency judgment for a foreclosure in Illinois for $70k and moves to Florida, can the bank collect, garnish wages, etc.?
    0 Votes

  • SS
    Apr, 2014
    Shelly
    Illinois: We went through foreclosure in 2010 with Bank of America (1st) and US Bank (2nd). BoA bought out the 2nd and then sent it to Green Tree Servicing to collect. We initially had an offer to pay $7k but that was then taken back and it was back up to $45k. For the past 4 years we have been trying to negotiate with GTS to no avail, they would not come down at all. Today I received a letter from a lawyer stating that BoA wants to claim still 100% of the debt or face litigation. Do I still have a leg to negotiate on here? Everything I have read is that this sold-out junior is an unsecured debt and the banks will negotiate, am I in the clouds? Is anyone else going through this with BoA?
    0 Votes

    • BA
      Apr, 2014
      Bill
      Ignore everything you read online except for this advice: Consult with an Illinois lawyer who has experience with mortgage litigation. Illinois is not a no-recourse state, but judges apparently have wide discretion in allowing or not allowing deficiency judgments. An Illinois lawyer experienced in this specialty of the law with knowledge of how courts in your area decide cases like these will be more valuable and useful to you than our opinion.
      1 Votes

  • JR
    Mar, 2014
    Jessie
    Hi, I own a home in Philadelphia that's been my residence since purchase in 2006. The house is underwater by 60-80k. I lost my job in 2012 and after my unemployment ran out, I took whatever savings I had left and put it into starting a new business so I could have steady income again. I also stopped paying my mortgage. The home is not in a good area and I have a child who will need to start school soon. The loan is FHA. In October 2013, we moved some of our stuff out of the house in order to de-clutter and put it up for sale. We began staying with my in-laws because it is very close to my new business and they watch my kids while I'm at work anyway. I submitted the non-HAMP (I think) application to the lender to get a short sale approved and we put the house on the market. On the application, I had to check whether the house was owner occupied, vacant, or tenant occupied. I checked owner occupied because most of our furniture and belongings are still in the house and we continue to maintain it, but we sleep at my in-laws. A modification was recently denied and now it's under consideration for short sale. The bank has also filed a foreclosure action against me and the process server has filed affidavits with the court that the house is abandoned/vacant because no one was there to accept service. the short sale form expires every 90 days and I have to tick the box again. 1)Not sure if I should keep stating it's owner occupied? 2)maybe just allow foreclosure?
    0 Votes

    • BA
      Mar, 2014
      Bill
      The rules for occupation are vague, at best.

      I would argue you still occupy the property because your personal items are still on site, you have the sole right to occupy the property, you still maintain the property, and I would imagine are still paying the utilities and so on. The fact you sleep elsewhere is irrelevant in my humble opinion.

      I hasten to add that's my definition of occupation, which may not square with your mortgage servicer's.
      0 Votes

  • JF
    Feb, 2014
    Jeff
    I have a FHA condo loan located in Florida. It was a primary residence and to make a long story short we left it due to structural issues with mold. We wanted to short sale the condo but the bank denied everything. It is now 2014, and now I'm worried about the 1099-c. Can they include all the back due interest, their lawyer fees, plus late fees with the 1099-c amount? Also there was a comment in the article about negotiating with the creditor to pay 5% of the charge off amount. Can they still 1099-c me if I pay them 5%? Can they double dip and hit me twice with a 1099-c plus sue?
    0 Votes

    • BA
      Feb, 2014
      Bill
      It is possible for fees allowed by your contract and state law to be added to the balance due on your home loan, which may be shown in your 1099-C. Original creditors sell collection accounts for a small fraction of their face value. We don't know how much mortgage deficiency balances fetch, and our guess is about 10 cents on the dollar.

      Let's simplify the facts here to illustrate how a 1099-C is supposed to work. Let's say you borrow $1 million from a bank. You repay the bank $600,000 and then default on the rest. The bank, by law, must issue you a 1099-C for the $400,000 amount it moved from its current accounts ledger to the bad-debt line on its general ledger. The bank still has the right to collect the $400,000 from you, or it may sell the collection account to a collection agent. If you never repay the $400,000, you must file the 1099-C and deal with the tax consequences. If you eventually repay the $400,000, both you and the bank may need to file amended tax returns.

      To answer your last question directly, the bank may issue a 1099-C and file a breach of contract lawsuit against you.
      0 Votes