Many homeowners and agents alike as what the odds are they will be required to pay a deficiency balance after a short sale. Many bank release documents will not specificially state whether the short sale will be in full satisfaction of the debt.
We've noticed a gradual change from a willingness to include language forgiving the debt to some even stating specifically that they are leaving open the possibility of seeking the deficiency balance, even though in fact they may not likely pursue it, unless of course, the debt is far in excess of the fair market value and the homeowner may either have assets or can be rehabilitated.
Pursuing the deficiency balance
The decision whether to pursue a deficiency balance rests with the secondary market investor (SMI) unless the servicing agreement permits the servicing lender to do so.
Then, the policy decision may be made from a public relations and political analysis. With the federal government so actively involved in the explosion of foreclosures, bailout programs, and attempts to reduce foreclosures, there is presently negative pressure on lenders to not pursue deficiency balances. This pressure will help determine whether to go after only the most egregious cases or to expand the criteria.
Finally, the decision for pursue a deficiency balance involves the a nexus between the capacity of their legal, bankruptcy, and collections departments and the facts of each case. A certain predictable percentage of their customers will file bankruptcies, so these entities will determine how many and which customers to pursue for the deficiency.
The borrowers likely to be pursued are those who the lender sees may become solvent in a reasonable length of time. If the servicing lender owns the note, they may be more aggressive. A medical doctor in his 40's, with a good income with a temporary financial trouble due to loss of business from the clinic mismanagement will likely recover financially after his change of clinic. Particlurly if a deficiency is large, the greater the likelihood they will pursue the borrower.
How to know when the borrower is in the clear
Each state has laws called "Statutes of Limitations" or "Limitations on Actions". These are laws that place a time limit after which the creditor can no longer sue a debtor for a debt, which can range from 2 years to 10 20 years. However, the borrower will seldom need to wait this long. Even the IRS does not collect tax debts after 10 years, with exceptions.
If the lender required a Promissory Note for part of the deficiency, it is highly unlikely that they will seek
more. Indeed, if they do, the lender may face some legal trouble, for which they are fully aware.
If a lender is going to seek a deficiency, it most likely will occur within the first year. Each year, in January, the lenders must issue their 1099s. A 1099A or 1099C will be the form they use to report to the IRS the amount that has been forgiven in a short sale or foreclosure. So, if the borrowers receive a 1099 for the deficiency balance, the lender may be "estopped" thereafter from pursuing the debtors. The lender receives a tax benefit from the forgiveness, and the borrower may incur a taxable event as a result, so the lender may be estopped from further action.
This discussion is only a guide, and there are differences between specific lenders and SMIs. It is important to encourage your sellers to consult with a competitent attorney in their local jurisdiction.
Please note: I have endeavored to provide general guidelines. Because there are a lot of SMIs, and even greater numbers of servicing lenders, many thousands of varying loan products, and often different procedures in different states or regions, many of you may find cases that deviate from the above discussion. Please keep this in mind.
Best wishes to you all,
Ken Lawson JD
TheLawsonGroup Mediation Services
Training, Coaching, and Mediation of short sales
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