When a foreclosure is finished and the home is sold or assessed by an
appraisal, for the loss on the mortgage, the deficit amount the bank
will not get back from the mortgage balance and expenses due, is called
a deficiency. In most states, the lender has an option to get a
judgment in this amount against the borrower and this is called a
"deficiency judgment". In addition to the loss of the homeowner’s home
he also has the potential of having to repay this judgment in the
future.
Even if the bank accepts a "deed in lieu of foreclosure" they can still
get a deficiency judgment against the borrower. The borrower is the one
responsible for the mortgage or deed of trust payments and he may or
may not be the homeowner. If the homeowner has a co-signer, the
co-signer will be as legally responsible as the borrower to pay back
the deficit due. Depending on whether the foreclosure is judicial or
non-judicial, and the specific terms of the mortgage, the bank may not
be able to seek a deficiency judgment. These laws vary state-by-state
and should be reviewed carefully to determine which applies to the
reader.
The bank doesn’t just have the amount of the unpaid loan balance
due but also legal fees, accelerated interest payments, back principal
payments, in some cases pre-payment penalties, and other expenses as
part of the judgment amount. This is why a homeowner who has had his
mortgage a couple of years could owe more than he borrowed originally.
As an example, the homeowner borrowed $200,000 in June of 2006 and in
January of 2008 he goes into foreclosure and the final judgment against
him could be $218,000! This is because of the additional expenses and
the fact that he pays mostly interest in the first 10 years of his
mortgage.
The largest loss the lender has is his loss of the ability to loan
about 7 - 10 times the unpaid mortgage balance. This is because the
Federal Reserve requires the banks to put cash into a non-interest
bearing account to cover potential losses. Since the bank can no longer
use these funds to get additional loans from the Fed, he is losing
tremendous loan power. This loss of revenue to the lender can not be
passed on to the homeowner or borrower.
The major factors in deciding whether the lender will pursue a
deficiency judgment are whether the lender feels he can collect the
judgment and the cost to collect it. In the process of working with the
homeowner, the lender pulls his credit and can see what other
outstanding bills he has and whether they are being paid timely. The
lender can not see what assets the homeowner has but can sometimes see
where he works. The homeowner will be asked to fill out a Net Worth
Statement ("NWS") which will disclose these assets to the lender. This
document is a major part of the decision to pursue the judgment or not.
If the lender has no reason to believe the homeowner has extensive
assets, they will issue the IRS Form instead. A note of caution -
falsifying the NWS can be bank fraud in some states so be careful if
you intend to return the NWS to the lender.
The deficiency judgment is determined by the court-approved "Final
Judgment" amount in most states. However, in some states, the property
must be sold or an appraisal done to determine the "expected" net loss.
If your state does this procedure by appraisal, contest the appraisal
and have the judgment lowered if you believe it was not correct.
The lender usually chooses not to get a deficiency judgment and
instead report the loan deficiency amount on IRS Form 1099. The result
to the homeowner is a "phantom income" requires him to pay income taxes
on this amount. In this situation the final cost of the guarantor’s
foreclosure is the amount of income taxes he pays the IRS instead of
the entire deficiency judgment. This is a substantial savings to the
homeowner and the lender also benefits because there is no collection
on his books that is counted as a liability. Unless there is suspicion
of fraud in the original loan, the lender will issue a 1099. In
December of 2007 legislation was enacted that allows a maximum
exemption amount a homeowner who resides in his property can write off
for this deficiency amount.
Carefully weigh your rights and options when you make a decision to
allow your home to be lost to foreclosure, as there are solutions
besides foreclosure and deed transfer to the lender. Do not be
paralyzed with fear that the lender will follow you forever to collect
the deficiency judgment, as you have a number of options to fight this
including attacking the validity of the original loan.
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