Short Sale “Promissory Notes” and Foreclosure “Deficiency Judgements”: How Much Will YOU Owe YOUR BANK After a SHORT SALE VS FORECLOSURE?
Every homeowner who is looking to short sale their property should be asking the following question: “On a short sale, will I have to pay the bank the difference between what I owe and the final sales price of my property?” The answer to this is both yes and no. Don’t worry, I’ll make it simple for you to understand.
*UPDATE 3/13/10 Feel free to visit my new blog post regarding how to negotiate & waive short sale deficiency balances*
#1: Let’s define terms:
Foreclosure Deficiency Judgment: A deficiency judgment is a lien against the borrower whose foreclosure does not produce sufficient funds to pay the mortgage in full. It is an actual judgment, that is, you are being sued. Thus, the borrower is liable to pay the difference between what they owe and what it sells for on a short sale or in an auction. The option to pursue the borrower is only available if the lender proceeds with a Judicial Foreclosure (basically, the lender sues you for the difference). Keep in mind that in a Non-Judicial Foreclosure, the junior lienholder can still pursue a deficiency judgement in many states. All of this can be determined based on original loan documents and/or the type of loan/lender.
Short Sale Deficiencies as Unsecured Notes: Short sale deficiencies are realized when the short sale does not produce sufficient funds to pay the mortgage in full. Short sale deficiencies are typically:
a. Waived in exchange for a pay off
b. Accounted for via promissory note for the deficient balance or percentage of the balance
c. Collected after the short sale as unsecured notes, that is, they will not be able to secure the lien against your other assets (since you’ve already sold the collateral property in a short sale) unless they actually sue you. Again, unless the lender/PMI/collections agency sues you in court and actually files a “deficiency judgment” against you, the note shall remain unsecured. For the most part, lenders will not sue their borrowers as it is more costly for them to do so then to keep in unsecured. Lenders often “reserve the right to pursue the deficiency” in a short sale, but what typically ends up happening is that the unsecured note most likely ends up being substituted with a 1099 (tax on sale) for the deficient balance (which they will charge off), which most homeowners are exempt from (Mortgage Forgiveness Debt Relief Act of 2007).
I Think I`ve Been Hit With an Invoice for the Deficiency/ I think I’ve Been Sued for a Deficiency Judgment: No need to fret. We can help significantly reduce and ultimately eliminate unsecured notes and deficiency judgments whether it was incurred via short sale or foreclosure.
Promissory Note: A promissory note is also an unsecured note and a contract between the lender and borrower where the borrower agrees to pay the difference (or a percentage of the difference) between the amount owed and the sales price of the property. This is usually presented during a short sale and can only be enforced if the borrower agrees in writing. These notes are also negotiable after the short sale.
#2: Let me explain why you are better off pursuing a short sale vs. a foreclosure.
In Washington state, a majority of foreclosures will be non-judicial, meaning that the lender will not be able to pursue you, the borrower, for a deficiency judgment. However, in other states, as well as some WA. based lenders (ie. BECU) do proceed with judicial foreclosures and borrowers may be liable to pay a deficiency judgment.
The number one reason why we advocate pursuing a short sale vs. a foreclosure, is that a foreclosure (regardless of whether it is a non-judicial or judicial foreclosure), will prevent you from obtaining a mortgage for a minimum of 5 years, in addition to extensive damage to your credit, whereas a short sale will have far less damage to your credit in that most borrowers will be able to obtain a mortgage after 2 years of conducting a short sale. Also, the deficiency (or tax consequences) in the event of foreclosure, if is collectable, will be significantly higher than in a short sale (since properties sell at extremely discounted prices at foreclosure auctions).
The second reason why we advocate short sales is that promissory notes and deficiency judgments before and after the sale are, for the most part, negotiable. In many cases, the deficiency owed can be negotiated to a percentage (ie. 10% of a Bank of America HELOC loan) or sometimes completely waived. The lender may forgive the balance in exchange for a small pay off or an affordable payment arrangement with the borrower. This largely depends on two factors: 1. The strength of the negotiator 2. Lender policy and type of loan. Sometimes, it is even possible to have the buyer pay the difference!
Again, should the lender reserve the right to pursue a deficiency, at least you have a short sale on your credit report vs. a foreclosure. Keep in mind that it is rare for the lender to actually pursue the deficiency and therefore the unsecured note will most likely be replaced with a 1099 issued by the IRS for the taxes owed on the sale. You will want to explore the Mortgage Forgiveness Debt Relief Act of 2007 to verify whether you are exempt from this tax.
In addition, if the remaining deficiency is pursued by the lender, the deficient amount can, even after the short sale, be negotiated down further with the assistance of an experienced debt negotiations specialist. Keep in mind, there are situations where the lender will absolutely not allow a short sale unless the homeowner signs a promissory note for the full amount of the difference. We have recently discovered that BECU will not approve a majority of their short sales unless the homeowner signs a promissory note for the full amount (our team has, however, been able to negotiate these down to a fraction of the deficiency).
In these situations, I strongly suggest hiring a professional short sale negotiator to aggressively negotiate the balance before the short sale as much as possible, then having a debt negotiation specialist pick up the tab after the short sale. You will want to explore these options before considering to file for BK.
#3: Finally, let me answer this question in the simple terms: “On a short sale, will I have to pay the bank the difference between what I owe and the final sales price of my property?”
Yes: As we discussed earlier, the lender may ask you to pay the difference in the form of a promissory note and will not allow a short sale unless a note for the full amount is signed by the borrower or the “right to reserve to pursue a deficiency” is outlined in a statement signed by you. In these situations, again, it may be in your best interest to have your short sale negotiator bring down the balance as much as possible before the short sale, then to have a debt negotiation specialist negotiate the balance even further after the short sale (if the deficiency is actually pursued by the lender/pmi/collections agency).
No: It is possible, in a short sale, to negotiate the deficiency owed down to a percentage that can be paid or to even waive the liability completely. What this means is that, say, if you owe $500,000 to your lender but your property sells for $350,000, a strong negotiator may be able to get the lender to settle at $350,000 and not pursue the deficiency with the homeowner (in exchange for a pay off or sometimes a payment arrangement with the borrower). That means the homeowner will be able to walk away from their short sale (although they may owe the IRS a tax for the difference, which most homeowners are eligible for exemption under the Mortgage Forgiveness Debt Relief Act of 2007). A negotiator will accomplish this by demonstrating to the lender what their losses will be in the event that you, the borrower, allow the property to go into foreclosure or if you file for bankruptcy. The negotiator will argue that it is in their best interest to proceed with the short sale, and will present all the market data, financial comparison sheet, etc. in order to make a strong case.
Hopefully this answers many of your questions regarding deficiency judgments, unsecured notes, promissory notes and how they relate to short sales and foreclosures. If you have any questions, just respond. You WILL receive a prompt response.