Wednesday, October 12, 2011

Debt Defense Must Read Alert: Principles and Strategies for Dealing with Deficiency

The Wall Street Journal reported in its aptly named article House Is Gone but the Debt Lives On that lenders and/or third party debt collectors are suing borrowers for deficiency judgments. 

This is not a new issue. This has been a growing concern among borrowers. There is a dawning realization that if a property cannot pay off the mortgage loan balance in full then the borrower will be responsible for the shortage. We talked about deficiency debt in our March 2010 post entitled Plan To Be Followed When You Walk Away From Debt. As predicted, there has been an increase in lawsuits for deficiency judgments.

This current post focuses on principles and strategies that can be a guide  towards resolving deficiency debt.

A deficiency debt arises when a property sold at a foreclosure auction cannot generate enough proceeds to pay off the entire loan amount. If a lender can prove to a court that a borrower is personally responsible for the payment of a deficiency debt then the lender can obtain a deficiency judgment against a borrower. A deficiency judgment is a court order that directs a debtor to pay the lender a certain amount of money. A deficiency judgment includes the principle balance, unpaid interest, legal fees, escrows, and/other costs. A deficiency judgment allows the lender to collect interest until the balance is paid in full. It provides a lender with various tools to collect the judgment such as the right to garnish wages, the right to place a hold on a bank account, and the right to place a lien on personal property or real estate. A deficiency judgment can appear on a credit report. If you are not clear about deficiency debt please read the article What Everyone Should Now About Debt Forgiveness, Obligations, and Deficiency.  

There are three alternatives that can arise from the auction of a property at a foreclosure sale:

  1. The property is sold to the highest bidder or,
  2. The lender takes the property in full satisfaction of the debt or,
  3. The borrower redeems the property by paying in full at auction.  
If a lender takes the property at an auction then there is no deficiency debt arising from the loan made by the lender. If the lender decides to take a cash bid at an auction, instead of the property, then the borrower may be responsible for the difference between the total amount due on the loan and the amount collected from the cash bid.  

Keep in mind that an auction may not always eliminate a second mortgage and/or Home Equity Line of Credit ("HELOC"). A foreclosure auction typically deals with the loan that is the subject of the foreclosure lawsuit. A foreclosure lawsuit is usually started by the first lien mortgage lender. A borrower can still remain liable for a second mortgage and/or HELOC after the first lien mortgage lender takes the property at an auction.

Each state has specific laws governing the collection of a deficiency debt. In some cases, states prohibit the creditor from seeking more than the collateral used to secure the loan. This is called “non-recourse” or “anti-deficiency.” This means that a creditor cannot hold the borrower personally liable for more than the value of the property at the time of sale. In a “recourse” jurisdiction such as Ohio, if a borrower owes a lender an $100,000 deficiency after a foreclosure sale, then the lender can sue the borrower for the difference, i.e., get a deficiency judgment against a borrower. You can learn more by reading What Is The Difference Between Non-Recourse and Recourse States. 

The WSJ article contained important points which should serve to remind all strategic defaulters about the need to develop a written action plan. The following are the main points from the article: