A person borrowing money to buy a home assumes the loan is secured by the mortgage lien on the house. In the event the house is sold in a foreclosure, they might also assume the debt has been satisfied. But that is not the case! There are two aspects to a mortgage loan. The first is the note, which is simply an IOU, a personal obligation. The mortgage is a lien on the house that serves as collateral for the loan. When the house is sold in a foreclosure, the proceeds from the sale go towards payment of the note; however, if the proceeds do not pay off the entire debt, the financial institution can still seek to collect the balance due. The note, an IOU, is an obligation that is not satisfied simply by sale of the home.
When the proceeds from the foreclosure sale of the home do not satisfy the entire obligation owed to the financial institution, they can bring an application for a deficiency judgment. The amount of the deficiency judgment is the unpaid balance of the mortgage loan left unsatisfied by the proceeds from the sale of the home.
In a case where $400,000 is owed on the mortgage and the house is sold in a foreclosure sale for $300,000, there would be a balance due and owing on the note of $100,000. The financial institution can move for a deficiency judgment against the homeowners for the $100,000 that is still owed. The bank can garnish the homeowners’ wages, tie up their bank accounts, or take other action to collect on this deficiency judgment. John Mixon, a retired professor from the University of Houston Law Center, has stated, “Deficiency judgments are absolutely devastating to the foreclosed home buyer both as a matter of immediate financial impact and income tax consequence.” Fannie Mae and Freddie Mac, the two quasi-governmental loan agencies, take the position that deficiency judgments may be necessary to recoup monies lost as a result of the real estate crisis.
Bankruptcies and Deficiency Judgments
Individuals faced with a potential deficiency judgment can file for Chapter 7 bankruptcy and eliminate their personal liability for the unpaid portion of the mortgage debt. In some situations, this is the best option for a homeowner facing a potential deficiency judgment.
Elliot Schlissel is an attorney licensed to practice in the State of New York. His law firm, with offices in Nassau County, Suffolk County and Queens County, practices in family law & divorce, criminal law, personal injury matters, bankruptcy, and foreclosure defense.