If there is no equity in the property, then it will most likely produce a result where the sale of the property will not be sufficient to pay the entire loan balance in full. This remaining balance after the sale is what is commonly known as the ‘deficiency.' The lender's are fully within their right to pursue the full amount of any deficiency, as the borrowers signed an unconditional promise to pay the full amount of the loan when the property was purchased. Whether or not the lender is going to decide to collect the deficiency is usually not determined until the last minute. If the lender decides not to collect the deficiency, then they will cancel the debt and report the canceled amount to the IRS as taxable, 1099 income to the borrower. The lender can decide on a combination to partially collect some of the deficiency, and to partially cancel some of the deficiency, but they can not collect 100% and report 100% as canceled debt. For example, if the property is sold for $150,000.00, and the remaining loan balance is $200,000.00, then the deficiency amount would be $50,000.00. A lender could either collect the $50,000.00, or report the $50,000.00 as canceled debt. The lender could also collect $25,000.00 and report $25,000.00 as canceled debt. However, the lender can not collect $50,000.00 and report $50,000.00 as canceled debt. In most cases, the lender's will cancel 100% of the debt, as they must receive a more advantageous treatment somewhere else on their own business books by doing so by showing this loss.
To the extent that the borrower has non-exempt assets to pay the deficiency, the more likely the lender is to try and collect all or a part of the deficiency. In Florida, and probably a lot of other states, exempt assets would include a person's homestead, automobiles, 401 K Plan's, IRA's and other similar retirement accounts. Also, to the extent the lender has ‘private mortgage insurance' (PMI), the more likely that the debt will collected upon. PMI is extra insurance that lenders require from most borrower's who obtain loans that are more than 80 percent of their new home's value. In other words, borrowers with less than a 20 percent down payment are normally required to pay PMI. The reason PMI is more likely to produce a collection scenario is that the insurance company will have to pay out a claim usually equal to the lender's loss. When an insurance company has to pay an insurance claim due to a possible at fault party, the defaulting borrower, they will step into the shoes of the lender in a legal process known as ‘subrogation.' When the insurance company subrogates in, they will generally bring in their own lawyers, and well, the insurance litigators are a different breed of lawyers than the bankers.
Please keep in mind that the issues of a deficiency are created as a result of the foreclosure law suit, not due to the fact that a borrower may choose to do a ‘short sale.' This is a common misunderstanding. If a borrower fails to pay the mortgage, and the property has no equity, then the deficiency will be there even if the lender ‘short sells' the property for the borrower at a foreclosure auction sale. However, the lender's auction sale will generally be a much ‘shorter sale' than even a reduced price on the open real estate market. Even if another third party does decide to bid at the foreclosure sale, the amounts generally bid are, again, much less than even a reduced price on the open real estate market. In theory, the public auction sale is supposed to produce an audience that will create a competitive bidding environment that will drive up the property to its highest value. However, from experience, this is often not the case. The foreclosure auctions are usually advertised very poorly and ineffectively in minor local news paper publications that generally have very small circulations and are very limited in additional content outside of the legal notices. In addition, public foreclosure auctions are generally cash auctions. Any successful third party bidders will have to put down a deposit the dale of the sale, and will have to pay the entire balance within 48 hours. Furthermore, public foreclosure auctions are generally attended by the same group of investors who are there to get a great deal, not pay top dollar. Also, the sales are usually held on week days during work hours. As a result of these factors, the public foreclosure auctions do not generally produce the type of bidding audience that may produce a higher amount than the open real estate market. In fact, many lenders often buy back the borrower's property at these auction sales for $100.00 because no one else bids on the property. It is the opinion of this writer that until that the governmental units conducting these distress sales must realize the value of the internet and employing a web based advertising and bidding system, or even out source the services providers such as ebay.com. Otherwise, the auction sale results will stay the same as they always have.