Short Sales and Deficiency Judgements

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After a successful short sale has been negotiated, there is a potential liability out there that sellers need to be aware of.  Lenders, or even the PMI company, may come after the owner for a deficiency judgement.  This can be negotiated out, with varying degrees of success depending on the loan servicer, as part of the offer.  But remember, if the home is foreclosed on, it is pretty much guaranteed that a deficiency will be filed. 

So what is the difference between the two possible outcomes? 

A 'release' means that the the lender will offer to forego their interest in your property in exchange for less than you owe on their note.  This process allows the property to be sold without satisfying all of the original terms.  This does not mean that the account is satisfied though.  As with anything else, there are advantages and disadvantages.  The biggest plus to accepting a release is that you get to legally convey title to your buyer, and avoid a foreclosure.  The bad part is, you can still be liable for the difference and owe money to your lender after the sale.  This brings up the importance of your hardship letter.  Many people think this is a factor in determing wether or not the offer is accepted, and that's not entirely true.  When determining whether or not to take your offer, the numbers are what the bank wants to see.  When determining whether or not to file a deficiency, the letter is what the bank wants to see.  Deficiencies are also based on a full understanding of the owners' current financial status and the likelyhood of repayment.  After you are no longer the owner, the bank doesn't have any leverage, or security, for their note. 

Since deficiencies are not secured by the property, the terms of the promissary note are usually fairly flexible.  They get you to a payment that they know you can afford, and they won't normally charge any interest on the note either.  Theses notes can also be renegotiated after a certain amount of time; say 18-24 months.  If you've been paying on time, request that the note be marked as satisfied.  Or offer a small settlement if you can.

A 'satisfaction' is when the lender agrees to release their lien entirely and no furter obligation is incurred.  This is the best-case scenario for owners, and something that I work very hard to make happen for my clients.  In fact, it's in my cover letter that our offer is for payment in full.  The negative side, yes there is one, is that there may be some tax consequences.  The IRS looks at the forgiven debt as 'phantom' income, and they may issue the owner a 1099 at the end of the year.  This does not mean that you will be responsible for the entire amount.  For example: You owe $200K and an accepted offer is for $175K.  That $25K is what you would pay taxes on, not the amount you still owe.  Congress did pass HB3648 (The Mortgage Forgiveness Debt Relief Act of 2007) at the very end of last year to help owners combat this obligation. 

Hopefully this helps give a better understanding of what can happen after the sale.  Please also see my disclaimer post here.

Posted by


Nick Dailey (CDPE) - Short Sale & Investment Specialist - Northern Kentucky & Greater Cincinnati

Helping families in Northern Kentucky avoid foreclosure.  Northern Kentucky MLS listings of homes for sale.  


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RC Cutcher

Can you give a bit more of an explanation of how HB3648 will be implemented with owner occupied Sellers who have no other loans or liens against the property?  Thanks.  RC Cutcher

Jul 15, 2008 08:36 AM #1
Sheila Vardakis
Keller Williams Realty Partners - Overland Park, KS

The HB3648 Mortgage Relief Act applies to owner occupants only.  So if you are an investor, you can pretty much guarantee you will pay taxes on the deficiency amount on the 1099 sent to you.  This is what I have experienced but I always encourage my client to contact their tax accountant for further clarification.   Sheila

Jul 15, 2008 10:04 AM #2
Denice Cleveland

My bank has accepted my short sale with  me bringing another $40,000 to closing (in lieu of me signing a promissory note for $75,000).  The bank analyst told me that the bank never gives the client a letter that states that loan has been satisified, but that I am off the hook for any remaining balance.  Have you ever heard of this? 


Also, if the bank does not send you a 1099 do you still have to report to IRS?


Thank you for response,


Apr 26, 2009 01:20 AM #3

Do you have a sample letter that you use for a mortgage "satisfaction" upon a short sale approval?

May 29, 2009 10:05 AM #4
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Nick Dailey

RE/MAX: Northern Kentucky Real Estate - NKY MLS - Short Sale
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