What are deficiency judgments? (Part 3 - short sale / foreclosure deficiency judgments)
This portion of our short sale / foreclosure article series needs to be Arizona specific. If you live outside of AZ you may want to read on anyway just to get some concepts straight but please note that every state is different. We have seen many articles and much "advice" out there that treats deficiencies on loans as if the rules are "cookie cutter" no matter where you live or that your property is located. They simply aren't.
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A deficiency on a loan is the principal and interest due amount left over after the loan has been disposed of in some manner other than paying it off in full. In a foreclosure where the property is worth less than the loan amount this would be approximately the difference between the home "value" at foreclosure and the balance of the foreclosed loan(s). As an example, if a home has a loan of $250,000 and the value of the home at foreclosure is $175,000 then there remains a deficiency on the loan after foreclosure of approximately $75,000 ($250,000 loan minus $175,000 property value).
Also, contrary to what a lot of people believe, the same can be said of a short sale. It is not an "automatic" that if the bank accepts a short sale there will be no deficiency for them to collect on. Unless there is wording in the short sale acceptance from the lender that says something to the affect "payment in full" then a person could get a nasty surprise when the bank continues to collect on the loan(s) AFTER the short sale! Also do not make the mistake of thinking this is rare or won't happen under a particular set of circumstances. It is actually VERY VERY common!
These deficiency amounts are very important because the lender can continue to collect after the disposal of the property. Judgments can (and often will) be obtained and wages garnished, assets seized (bank accounts, etc) and so forth. Bankruptcy often becomes the only solution AND THIS IS AFTER WHAT MANY PEOPLE CONSIDER TO BE THE "END OF THE LINE" TO THEIR SITUATION - THE ACTUAL FORECLOSURE OR SHORT SALE!
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The rare good news to this is that a few states have some form or another of deficiency protection for certain types of loans, including some mortgages. The rules vary and can be somewhat complex. In Arizona, for example, if the home foreclosed on is on less than two and one half acres and is used as a single or two-family residence there is very likely protection against deficiency judgments. These rules change, however, and in Arizona just very recently have (July 2009). As of late September 2009 Arizona will differentiate between most "investment" property (making it subject to deficiencies) and a person's primary residence (still protected). Action is being taken as this is written to change or rescind this new law prior to it taking affect but nothing is assured. The evidence is anecdotal at this point but it also appears some lenders are waiting until after September to foreclose simply so they have the option of collecting on the deficiency amount on certain loans!
In our prior article on IRS short sale and foreclosure issues we also discuss what happens if the bank waives the deficiency and treats the property loan(s) as "paid in full". All of these considerations are important.
The bottom line to this is that many people think that it is a fairly simple choice to choose between loan modification, foreclosure, short sale, and/or bankruptcy if they owe more on a house than what it is worth. Sadly, for the homeowner this is not true. If a person has a property in Arizona that they have questions on we invite them to contact us. We cannot give legal or tax advice but we are a licensed real estate brokerage in the state of Arizona and can help as it pertains to a property in this state. We also work with legal and tax professionals on an ongoing and regular basis. For properties outside of Arizona it is possible we may be able to recommend someone. Please feel free to contact us with both in state and out of state questions.
In our next to last part of this series (part 5) we will discuss the remaining serious issue in short sales and foreclosures, that being damage to credit. -back to tutorial index-
