Bills.com > Mortgage > Mortgages in Trouble > How a Deficiency Balance Can Affect You

How a Deficiency Balance Can Affect You

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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.

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

If you end up with a deficiency balance, consider negotiating with your creditor in an attempt to reach an out-of-court settlement on the debt. 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 offering the creditor 10 cents on the dollar for a lump-sum settlement.

Summary

If you end up with a deficiency balance, make sure that you understand what kind of financial and tax responsibilities can follow you, even after you lose or sell your home. Speak with an attorney or a tax specialist, so an expert can explain things to you. The last thing you want is for a problem that you thought was behind you to rear its head with IRS collection notices or a wage levy from a judgment your creditor obtained.

Comments (55)


Trish S.
Akron, OH  |  April 18, 2012
Hi I live in Ohio and am getting ready to do a short sale and they mentioned sending me a 1099-C and I have been trying to find out if Ohio is a debt forgiveness state or not so I know if I would have to pay taxes on this money or not. I did refinance the house once and paid off credit cards so I don't know how this would affect the 1099-C. If I have to pay taxes on this as income I am better off letting them foreclose and file Chapter 7 bankruptcy. Any help you can offer would be appreciated.
Bills.com
April 18, 2012
Homeowners face two potential issues following a short sale or foreclosure:
  1. Deficiency Balance: If the property sells for more than the balance of the loan, the difference between the two is call a surplus. If the property sells for less than the balance of the loan, this is called a deficiency. Some states have anti-deficiency laws that bar a lender from trying to collect the deficiency balance from the borrower. We summarize each state's laws on the Bills.com Anti-Deficiency page.
  2. Forgiven-Debt Income. If a financial institution that lends money as its business forgives or cancels a debt worth more than $600, it must issue a 1099-C, and the borrower must declare this as income on their tax return. However, the Mortgage Forgiveness Debt Relief Act and CODI can be used to cancel this imputed income.

Note that a state's anti-deficiency laws and the Mortgage Forgiveness Debt Relief Act concern the same thing — a mortgage deficiency balance. However, the state law focuses on collecting the debt, and the federal law focuses on the federal income tax implications.

You asked about bankruptcy and mentioned Ohio. Consult with an Ohio lawyer who has bankruptcy experience to learn more about your rights and liabilities, and whether you qualify for a chapter 7 or chapter 13 filing.

Tom R.
Ocala, FL  |  April 16, 2012
If I settle on a second mortgage on my primary residence and still live there, is the difference between the settlement amount and amount owed taxable? Or, can this difference be forgiven and not be reported as income?
Bills.com
April 16, 2012
Two questions:
  1. Was the deficiency balance forgiven? If yes, then the Mortgage Forgiveness Debt Relief Act may apply.
  2. Was the second used to buy, build or substantially improve your principal residence? If so, MFDRA applies.

Follow the link just mentioned to learn more. You may need to file a Form 982 with your tax return.

Phaedra T.
Milwaukee, WI  |  March 14, 2012
I live in Wisconsin. My home has lost considerable value and I am currently underwater. The balance of my mortgage is $115,000 and I was advised my home was worth $45,000 in 2011. In March 2011 I contacted my lender regarding a Short Sale or Deed in Lieu of. I was advised they would not consider the Deed in Lieu of unless I had attempted the Short Sale first. I placed the home on the market for $45,000. My lender had an independent appraiser look at the house and advised it was worth no more than $40,000. The lender denied the Short Sale. I have other debts totaling over $160,000 so I filed Chapter 13 and advised the lender that I did not want the home and they gave me the impression they would move forward with the Deed in Lieu of. I vacated the property June 2011 and moved to a rental. The bankruptcy court granted my lender a stay in June 2011, so I believed that they would eventually take possession of the home. I learned in November 2011, (and not from my lender who never bothered to contact me), that they had made a business decision not to foreclose, they wrote off the loan and the home was still in my name. I however no longer wanted the home or the resposibility (and apparently neither did the bank). The lender suggested I do a short sale. I explained I had already attempted that earlier and they had refused. In the 9 months that the home has been vacant the value has continued to decline. I had it listed again, this time at $29,900. My question is this: when the home sells, there will of course be a deficiency balance, since I filed Ch 13 and orginally listed the lender, can they attempt to collect the remaining charged off balance? I feel that some of the actions taken by my lender were not above board, do I have any recourse? The recently received an offer of only $11,500 which I am going to accept, just to get the home out of my name, but in your opinion, do you think the lender will say no or were they just forcing me to do the leg work of getting rid of the house?
Bills.com
March 14, 2012
Consult with your bankruptcy lawyer about the settlement the lender offered. As a person under chapter 13 protection, any settlement you make with one of your creditors outside of the chapter 13 process may kick you out of the chapter 13 and expose you to liability and court sanctions.
Shawn N.
Richmond, CA  |  February 24, 2012
I am a homeowner in CA who is underwater. I will try to be brief... We bought our home in 2004 with an 80/20 loan situation. After 1 year, we refinanced to consolidate the loans and improve the terms to a 30 year fixed interest rate. We did take a bit of money out when we refinanced in order to do some home improvements. Now, 8 years, and 2 extra kids later, we have outgrown our home and need to move. We are trying to explore all our options. We are presently considering purchasing a new home (we are preapproved...) with an FSH loan, then attempting to short sell our home. I am having a hard time understanding if the mortgage forgiveness act and CA SB 458 will protect us. If the loan non-recourse loan, I am under the impression that our additonal assets (ie: new property) would not be at risk. If the loan is a recourse loan, would our assets be at risk? ...even in CA? Finally, if our loan is a recourse loan and the above protections do not apply to us, and we do not proceed with purchase of another property, what are our options? Does a homeowner with a refinanced loan that is underwater have ANY options of getting out of their property?
Bills.com
February 27, 2012
Please see the Bills.com article Is My HELOC a Recourse or Non-Recourse Loan in California?, which discusses California's anti-deficiency laws in some detail.

Let me cut to the chase, as it were, and give you a short answer: In California, if you refinance a home loan, you lose California's anti-deficiency protection. Here, you mentioned a refinance, which is a recourse loan in California.

If a lender forgives a deficiency balance, then the Mortgage Forgiveness Debt Relief Act, a federal law for federal income taxes, and the California version for California income taxes, both apply. However, that assumes the lender forgiving a deficiency balance, which you should not take for granted.

Your best option? Buy the new home and short sale the second, in which you negotiate with the lender in an attempt to convince it to forgive the deficiency balance. Explain that if it does not, you are prepared to file for bankruptcy, which will discharge the deficiency balance.
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Shawn N.
Richmond, CA  |  February 27, 2012
Thanks for your reply! One more question...if you end up in the "worst case scenario" having to file for bankruptcy, do you lose the second house?
Bills.com
February 28, 2012
Let us assume the following chain of events:
  1. Borrower owns House A with current home loan payments
  2. Borrower buys House B
  3. Borrower tries to sell or short-sell House A
  4. Borrower short sells House A (or allows a foreclosure), and Lender does not forgive the deficiency balance
  5. Lender pursues Borrower aggressively and files a lawsuit
  6. Court gives Lender a judgment
  7. Lender threatens to use judgment to garnish Borrower's wages, place a lien on House B, and levy accounts of Borrower
  8. Borrower files for bankruptcy, and qualifies for chapter 7
  9. Bankruptcy trustee discharges Borrower's debts, including the judgment
  10. Borrower continues to pay home loan payments, but does not reaffirm mortgage/deed of trust

The Lender for House B has the ability to foreclose if Borrower stops making his or her monthly payments, just as it did before the bankruptcy. However, Borrower does not have personal liability for the home loan, nor will the home loan appear on his or her credit report.

Borrower's bankruptcy does not result in foreclosure if Borrower continues to make their monthly loan payments as agreed to in the loan contract.

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Shawn N.
Richmond, CA  |  February 28, 2012
Thank you! Great information!
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Kenneth Y.
San Marcos, CA  |  February 29, 2012
We're in kinda the same position. We're in California and we're trying to do a deed in lieu on a property in which we have a 1st and a 2nd that have both been refinanced. Our deed in lieu paperwork from the lender only applies to the first loan and the lender claims to have written off the 2nd. They say that there will be no collection attempts on the 2nd but they won't provide any paperwork that that effect. The 2nd is 74k. Should we believe them or do a short sale instead?
Bills.com
March 01, 2012
Whether you do a short sale, deed-in-lieu, or simply walked away, is there enough value in your home to pay anything to the second mortgage, after the first collects as much as it is able to collect? If not, trusting them is all you can do.
Wendi L.
No Miami Beach, FL  |  February 17, 2012
Question: I an currently undergoing foreclosure. I had two loans on the property. In a twist of fate, my first loan servicer purchased my second loan servicer. In June 2011, the second loan servicer cancelled my debt and issued a 1099-C. Then they were purchased in later 2011 by my first loan servicer. Now, I have gotten a 1099-C form from the second lender, but the first lender is sending me bills demanding that I pay the second loan (the amount that has been cancelled) along with the first loan. I already know that I will not incur taxes on the cancelled debt, but I was just wondering if my first lender coming after me for my second lender's cancelled debt is normal?
Larry M.
Orland Hills, IL  |  February 05, 2012
The short sale on my primary residence in IL closed in April 2011. The debt was forgiven on the 1st through BOA but I had a HELOC with Wells Fargo that wasn't forgiven for 30K. I attempted settlement but couldnt reach an agreement, which one of the reps tried since the debt was now unsecure but no luck. Wells has since sold/assigned the debt to a collection agency a few weeks ago. Since I no longer own the home I wanted to know what actions if any the collection agency can take against me?
Bills.com
February 05, 2012
You mentioned Illinois. See the Bills.com resource Illinois Collection Laws for a discussion of your rights and liabilities.
Qinah E.
Chicago, IL  |  January 09, 2012
They foreclosed on our rental property in October 2010. The mortgage was split between two banks (80/20). Bank 1 foreclosed and got the property. Bank 2 has a remaining balance, which was not delinquent at the time of foreclosure but we owe what I now know is called a deficiency balance. We have since "refinanced" into what I am assuming is just a regular 'personal loan' for the balance. We have been paying faithfully. My question now is...are any of these payments tax deductible since there is no RE interest or taxes to be gained from it?
Bills.com
January 10, 2012
Mortgage Interest is tax deductible for qualified homes, as defined by the IRS. Once the mortgage is paid off, including through a foreclosure, your unsecured loan is not eligible for a tax deduction.

However, I would like to add two points. Your mention that the property was a rental property, and not all rental properties are qualified homes. See the IRS publication 936 for more information. If the mortgage interest was deductible, upon paying off the mortgage, there may be prepaid points that are eligible for deduction.

In any case, I recommend that you consult with a tax professional.
Marie H.
Port Richey, FL  |  November 06, 2011
I had a home that was foreclosed on Florida. Here are the facts and then my questions. FACTS: 1. The home was foreclosed on in July, 2009 as reflected in the Final Judgement. 2. A Certificate of Title was filed in November, 2009 and sold to WFB as a trustee for the mortgage company. 3. The home was sold in October, 2010 as reflected in a Special Warranty Deed. 4. My credit report still indicates the Foreclosure Process started, two years after the Final Judgement. 5. The report shows a Past Due Amount and Last Past Due Amount for 10/09, 3 months after the property was foreclosed upon. 6. The Terms shows the incorrect monthly payment amount. 7. The mortgage company still shows a balance owing, greater than the original amount of loan. QUESTIONS I contacted the Mortgage company and was intially promised correction, then they back out of that promise. I was going to dispute with all 3 CB for all of the inaccuracies. Should I supply the CB with the actual court documents? Should I just ask for simple deletion for each and every error? Thank you!!
Bills.com
November 07, 2011
You will need to provide details regarding each disputed entry, with supporting documentation. Read the Bills.com article about disputing a credit report.

According to Experian's Web site, the date of foreclosure will be based on the filing date and will last 7 years. TransUnion's site explains that the amount reported is taken from the public record, and does not change after payments are made.
Tom R.
Oakland Park, FL  |  October 30, 2011
My investment property was just foreclosed upon by mortgage co Aug 31st, and I had a HELOC on the property too. The HELOC was taken first, THEN the mortgage. I am current on the HELOC. There will be a substantial deficiency on the property. Appraised value when bought was 180K, now worth 50K. HELOC is 78K, and mortgage 95K. What am I looking at down the road? The two other properties I own are way under water also, and I have no savings other than 50K in retirement account. Should I stop paying HELOC also and let the banks fight it out and decide what they will do with me? Still do not understand how mortgage co foreclosed on property when HELOC was first. confused here...
Bills.com
October 31, 2011
Your confusion regarding a mortgage company in second position foreclosing before the first mortgage is understandable. However, any company with a mortgage on your property, whose loan is in default, has the right to foreclose, regardless of its position.

It is true that it is not always economical for the second position holder to foreclose, because the proceeds of the sale will first go to the first mortgage holder and there may not be sufficient funds to cover any or all of its loan. Please read the Bills.com resource about second mortgage foreclosure.

Regarding your overall financial position and your other underwater properties, I recommend that you consult with a bankruptcy attorney. You could also try to negotiate with your lenders. Speak about a loan modification, one that would allow you to repay all of your loans satisfactorily, or a settlement to pay the principal balance at a reduced rate. If that is not possible (due to the lender's unwillingness to negotiate or your inability to service any negotiable loan) and the lender forecloses, then you can try to negotiate paying off a deficiency balance at a reduced rate.

If your only asset is your retirement account, which is generally off-limits to the creditors, and you wish to protect your income or any other assets from garnishments and levies, then a bankruptcy may be the best route to take, especially if you qualify for a Chapter 7 bankruptcy.
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Tom R.
Oakland Park, FL  |  November 01, 2011
Thank you for the information regarding the second foreclosing before 1st(HELOC). I understand what you are saying, but DONT understand what the mortgage company is doing.. Looked at my property online and condo has been sold to GMAC(the mortgage co) for $14,800! I also see that it is for sale thru a bank broker/real estate agent for 46K which is approx market price at present. I also have found out that the HELOC, which was first on the property (78K), looks like the mortgage co(GMAC) has written out any and all claims on the property on their foreclosure judgement. You said that if the second forecloses, then the HELOC would be paid off first, THEN the one who foreclosed would be paid off second, correct? Also reading thru court papers I see that mortgage company included in their paperwork to courts that the HELOC was old and already paid off and no claim is available for BOA, and was signed off on by the courts. Even though there is an outstanding 78K on my HELOC! So now what? I am ready to stop paying this BOA HELOC since it seems they have nothing to claim anymore. Also, if the mortgage company decides deficiency judgement on me, will they use the $14,800 price they just paid for the property with the county to decide the deficiency? Or the price they get when they sell it?? And if they decide to go after deficiency, will the HELOC be thrown in with it also? Know this is confusing to you, but I am even more confused of what is going on. I think GMAC as something up their sleeves for later, and I am wanting to cut them off at the pass! what is your gut feeling on this??
Bills.com
November 02, 2011
I can understand why you are confused. I cannot think of any reason why the second mortgage would be paid off before the first mortgage. In order to find out whether the foreclousre process was done properly I recommed that you speak with an attorney. Please report back and let us know how you resolve your problem. This may help other people.
Mike Y.
San Francisco, CA  |  September 25, 2011
Hi I have somewhat of an interesting situation. I own a condo in New Jersey. I bought it as owner occupied but had to move about a year after purchasing it to take a new job in California. The housing market collapsed shortly thereafter and the condo has been underwater for the last several years. I was able to rent it out most of the time, although being a landlord from 3,000 miles away is a bear. Up until now, I've made all of the payments, even for the almost two years that I was unemployed (I got laidoff from my job in California in 2009). I had a good amount of savings and the rental income helped cover a lot of the mortgage. Since I couldn't find a job, I started a business. While I was able to get a little bit of seed capital and make some money by working part-time on the side, the company is still a ways away from being profitable. Right now I have about enough money to cover my personal expenses and the business expenses if I don't continue making mortgage payments, and only a modest chance of getting more money after that. Meanwhile my mortgage related expenses have gone up. My HOA dues increased by 50%, my second mortgage which was interest only for the first several years is now in repayment and my taxes have increased. The end result is that my mortgage payment has increased significantly last year. Meanwhile, I haven't gotten any money from tenants in over 4 months. At this point I can't afford to maintain the condo and the business. I've reached to the bank in the past, but they don't seem particularly interested in working with me. I really need to get out of this condo, and I would like to avoid foreclosure. I have enough money to make one more payment at most, but am considering skipping it. Any advice?
Bills.com
September 25, 2011
I can't give you legal advice, but will share a few thoughts with you.

You don't say how underwater you are. You can try negotiating a short sale with your lenders. You can cease making payments and see if either lender is willing to modify your loan (or do so before you miss a payment). You can also try reaching out to an organization like Hope Now. Lastly, you can contact an attorney that has experience in negotiating short sales and avoiding foreclosure.

Some say that skipping a payment is a good way to alter the equation and gain some flexibility from a lender, but there is no guarantee that your lender will not pursue a foreclosure aggressively.
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