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 $350,000 and not pursue the deficiency with the homeowner (in exchange for a pay off or sometimes a payment arrangement with the borrower). That means the homeowner will be able to walk away from their short sale (although they may owe the IRS a tax for the difference, which most homeowners are eligible for exemption under the Mortgage Forgiveness Debt Relief Act of 2007). A negotiator will accomplish this by demonstrating to the lender what their losses will be in the event that you, the borrower, allow the property to go into foreclosure or if you file for bankruptcy. The negotiator will argue that it is in their best interest to proceed with the short sale, and will present all the market data, financial comparison sheet, etc. in order to make a strong case.
Hopefully this answers many of your questions regarding deficiency judgments, unsecured notes, promissory notes and how they relate to short sales and foreclosures. If you have any questions, just respond. You WILL receive a prompt response.
Your friend,
Kevin
Thanks for the clarifying information on short sales and deficiencies. Question: I’m in the final stages of a short sale with a 1st and 2nd lender. 1st lender has agreed to short sale with a 0$ promissory note,( 1st will be almost completely paid back via short sale). 2nd lender has asked for 10% of outstanding balance to be paid to them in order to release lien to buyer; this amount being paid by buyer. 2nd lender taking the brunt of the loss. 2nd lender sending over approval letter today. Also, BK, CH7 filed and discharged 6 mos ago and the 2nd lien was included in BK and discharged. Considering the 10% payment to 2nd lender and the discharged BK,( BEFORE short sale), what’s your opinion on 2nd lender trying to come after me, either before short sale via promissory note or after via deficiency judgment)?
Hey Kevin,
Good article, spoken from someone who truly has been down in trenches fighting the good fight!
It amazes me how many misinformed realtors there are telling people that a foreclosure would probably be better because of the possibility of a deficiency or 1099. I have witnessed it first hand…Talk about stepping over a dollar to save a penny.
The one thing I’m curious about is if you guys employ the back-to-back closing method? For my business this really helps setting up the spread in the middle that allows for any incidentals to be paid, such as deficiencies or promissory’s. This has saved countless deals from otherwise failing.
I have been slaying the foreclosure monster myself down here in Santa Barbara CA. It’s nice to know there are other intelligent people in the industry amongst all this ignorance.
Thanx Kevin!
Thanks for all of your comments. Please visit my new blog post with new information on how to deal with the deficiency balance:
http://seattleshortsaleblog.com/2010/03/13/how-to-negotiate-waive-a-short-sale-deficiency-balance/
Any comments on this? Because they specifically stated that they will not waive their deficiency rights does that mean that they will come after me for the difference or are they just covering their butts.
Also can the 15 K to PMI be negotiated down.
Any ideas are welcome.
Fannie Mae has approved the DIL but will not waive their deficiency rights and a 1099 C will be issued for the loss.
See the terms of the Promissory Note below.
Thank you for the deed in lieu request on the subject file. A recent credit report indicates that you are current on some of your other credit obligations at this time, including an auto loan. An approval of the DIL would obligate the Mortgage Insurance Company, Radian, to a claim payment of approximately $56,000. Radian will require that you agree to repay $15,000 (120 months at $125.00) of the anticipated loss as an interest free promissory note. This amount and/or repayment terms of this required unsecured note may be negotiable.
Kevin,
I am writing to update the progress of our short sale. We have had an approval for almost one month on our HELOC. We are still waiting for Wells Fargo to approve the 1st. Our contract is $24,000 less than what we owe them. We have been waiting for 3 months on Wells Fargo. We were told through email it was approved and they would be printing out the approval. Now a week later they say there is no approval yet. Our closing date was set for 5/25 since on 5/26 the HELOC approval expires. They extended it 10 days for Wells Fargo and if the house doesn’t close on 5/25 it will go under review again. This is now an 8 month nightmare. Our foreclosure sale was to take place 5/28. We had an email it would be extended 60 days but since we were misled on the approval we don’t trust the 60 day extension. All of our furniture/ tools are still in the home. We are at the point where we don’t have faith in anyone regarding this sale. Why do these banks do this??? Our first buyer walked away after waiting 3 months and it was a full price offer on the 1st. Still took Wells Fargo 2 months to decide if they would approve and then continued waiting for the HELOC, the buyer gave up! I seriously don’t ever want another thing to do with a bank after this experience. We have kept the home, pool, and yard neat while we struggled to buy groceries for ourselves and the bank could care less. No urgency and we are now 11 days away from the deadline. We just don’t understand how banks can treat homeowners like this when we tried our best to do what we thought was right. FICO score was 775 until the housing crashed.
Don’t bother with the banks they’ll give you hell just because you didn’t keep up with the contract. They’ll just take your home so best be prepared to move and find a place. If it’s your first only mortgage it’s rarely they’ll come after you. Short sales are pain in the ass because you have to please so many people and it winds of draining your pocket money. Sometimes, it’s best to think simple and know your routes.
Hi Kevin!
I am doing a short sale in Oregon. I have a 1st and 2nd mortgage. The 2nd is willing to say mortgage satisfied on the letter and I don’t have to sign it either. The 1st presented us with a lengthy offer, promisary note of $0.00 but it states that the balance after the short sale remains owing and if applicable it will be considered part of settlment and forgiven. We asked many times by email to change it but they refused. One day the negotiatior called and stated that the debt will be forgiven and I would get a 1099-c in 2011. We wrote one last email stating that we would terminate the sale if the bank wouldn’t answer the question:
Will my balance be considered part of settlement and forgiven?
They replied by email and all they said was Yes. A very short answer. We signed the short sale without specifically stating the mortgage satisfied but have the emails to back it up. Do you think this makes a strong court case if neccessary? Any input would be appreciated. You are the only one who has made sense in all this.
we have a short sale of our primary residence in california in july 2009. we did not sign a PN but the short sale has this language ” we reserve the right to pursue collection of remaining balance of loan xxxx (which is the equity line).”. our realtor did not explain this nor were we aware of it until i asked them why the collector is pursuing the balance of this loan. the realtor then showed me the approval letter which i dont remember seeing before we sign the short sale. my 2 sons were co-borrower. these loans were original purchase money loans, neither were refinanced. does the collector really pursue a judgment on me? can they also do that to my sons? both are employed, except for me. i received a 1099c for the first loan, in my credit report, the 2nd loan/equity loan showed as discharged/written off but why are they still pursuing to collect. do they really have a cause to do this? i asked collector to show me proof that this loan is pursuable but they just keep calling and causing me lots of sleepless nights because i am worried for my sons. the realtor wants me to pay them to negotiate a debt settlement but my thought is that they were negligent during the short sale for not looking after my interest, thats why this is happening. i have not talked to anyone but a BK atty for free consultation and they said i am not qualified bec i have savings on which i am living on. pls help me figure out my situation.
Hi Kevin!
I live in Oregon.
I have tried to catch your attention before but I have had no luck. We are 7 days away from completing a short sale. 1st mortgage is held by Suntrust. The offer letter dosen’t say that we are off the hook but it says that the balance remains owing after the short sale and if applicable it will be considered part of the settlement and forgiven. It has a promisary note of $0.00. They are unwilling to change the letter but called my realtor to say that I will get a 1099-C in 2011. Also, the sent us an email saying yes(it will be forgiven.) But no actual letter.
The second mortgage is held by United Guaranty. They sent us a letter that they will release the lien and the mortgage is satisfied. They don’t report to IRS or send out a 1099-C.
1. Can the first one come after us for a deficiency judment? Can a documented phone call or email be used in court?
2. If any entity forgives an amount shouldn’t they send a 1099-C?
We met with a real estate lawyer and still are unsure and thinking of backing out of this short sale but my realtor says that the buyers will take us to court.
Any comments about our case or the state of Oregon will be much appreciated.
Thank you Kevin
Hi Kevin,
What can we have our clients request from the bank, before we close the short sale, to make sure they do not receive a deficiency judgement from either the first or the second mortgage?
Thank You
How do realtor fees for a short sale factor in? If a seller agrees to pay a realtor 6% in a short sell, does the lendor simply transfer this cost to the seller by including it in the short fall sought via a promisory note?
Realtor costs are paid by the lender, and any deficiency realized in a sale is typically negotiated to be reduced or eliminated after the sale. There is not always a direct correlation between realtor costs and your deficiency (which the lender may try and cover by having you sign a promissory note).
The key to successfully settling your short sale is not to push out realtors for the purpose of saving 6%, rather, it is to have a solid negotiator who knows how to settle your short sale at the best terms possible
thank’s im clear on balanced owed
what happen on a bankruptcy, if you have not
established a trial modification dollar amount.
maenwhile you stay on premises for how long
If a borrower purchased a property in the state of CA as a N/O/O but has not refinanced the loans since the original purchase transaction and the property is about to be foreclosed upon, can the borrowers lender file a deficiency judgement against the borrower once the property has been foreclosed on?
Hi Renee,
I’ve done enough research that you WILL be protect under the one action rule if you didn’t refi or taken money out from your original loan. If time permit, you should talk to your lender and see if they are willing to let your take a shortsale WITHOUT collectible balance. shortsale is alot less damaging to your credit then a foreclosure.
if you don’t have any HELOCs (home equity line of credit). You should consider a shortsale.
You need to ask a Ca. based attorney about this:
http://seattleshortsaleblog.com/legal-counsel/
Hi Kevin:
thanks in advance for your response!
I’m in CA and got two HELOCs with BofA about to close my short sale.
I received a note from B o A that they agree to accept the short sale offer and will release the lien and charge off the remaining debit as a collectable balance. Their recovery department will be in contact with me to make arrangements on this balance. Will report the accout to the credit bureaus as “charged off ” and show the balance remaining owed to B o A.
After the shortsale goes through, I probably will have a 250K remaining balance. yes, it’s a large balance. This property was my primary residence. I thought I about foreclosure as well. However, giving the fact that my loans were HELOCs and I wouldn’t have protect by the one action law or qualify for the Debt Forgiveness Act. BofA WILLL NOT negosciate until the short sale is closed.
Do you think taken the short sale with collectible balance vs foreclosure is the right choice? I’m pretty much taken a chance that BofA might 1099 me end of the year giving that this is my primary residence and have no other property or major asset.
Whether you allow your property to go into foreclosure or not, your secondary lienholders will retain the right to pursue the deficiency. I say you wait, threaten BK using an inexpensive Pre Paid Legal attorney and ultimately see what the lender does. You need to prove to them that you are not worth suing.
thanks Kevin,
I drag this 9 months and they already issued a NOD (notice of deafult) and started the foreclosure process. They approve my short sale and the foreclosure process was postpone. I got until Sept 5, 2010 to complete the shortsale. BofA will not talk to me until the short sale is done. They keep repeating because my loans were HELOCs, they will not change the verbage on the collectible balance.
I opened escrow and started the short sale process.
again, I have no other signicant asset. If they come after me, I’ll just file BK. BK will be the final chapter if they want to push me that far.
What do you think?
I think that is wise. If your credit score is worth 250k to you, by all means, pay it up. However, 99.9999% of homeowners out there would rather have broken credit then a 250k bill
Ask a BK attorney about this:
http://seattleshortsaleblog.com/legal-counsel/
This was directed to Ephraim