No doubt, real estate foreclosure is a serious matter for anyone connected to the mortgage, including homeowner-borrowers, lenders and guarantors (they guarantee payment of the loan).

In addition to losing possession of the real estate, the homeowner-borrower (and any guarantor) may also face a personal judgment for the difference between the money made at the foreclosure sale and the mortgage loan balance, plus the lender's costs of the foreclosure action.

This personal judgment for the shortfall is called a deficiency judgment.

The Mortgage Is the Key

Most real estate mortgage deals involve two main documents:

  • A note from you (as the borrower or mortgagor) promising to repay the lender (the mortgagee)
  • A mortgage, which pledges the property as collateral to secure repayment of the loan

In order for a lender to get a deficiency judgment against you (or a guarantor), you must have agreed to be liable for any deficiency in case of foreclosure. Usually, this agreement is contained in the mortgage document. This type of mortgage is called a recourse mortgage. The mortgage is called a nonrecourse mortgage if you're not liable for any deficiency.

Who Can Get a Deficiency Judgment?

Anyone with a properly executed lien against a piece of property may be able to get a deficiency judgment. Most commonly, it's the lender with the "first mortgage" - usually the one used to buy the property - that sues for a deficiency judgment.

Other Lenders May Sue, Too

It's common for property owners to have more than one mortgage. These additional mortgages are called second or junior mortgages because they're paid off only after the first mortgage is paid off in a foreclosure.

Second mortgages often include:

  • Home equity lines of credit (HELOCs) or home equity loans 
  • Smaller second mortgages used as a part of a downpayment (called soft second mortgages)
  • Construction loans

Foreclosure laws vary by state, but generally they control:

  • Whether a second/junior lender can obtain a deficiency judgment in a foreclosure. The lender may have to file a separate lawsuit and get a judgment against you  
  • The specific and strict rules a second mortgage lender must follow 

Timing for Deficiency Judgments

There's no set rule about when lenders may decide to seek a deficiency judgment. Generally, they'll weigh the chance of success in collecting on a deficiency judgment against factors such as the time and expense involved. Lenders may be more willing to seek a deficiency judgment when borrowers have assets that could be a source of payment.

Seeking a deficiency judgment is a business decision for the lender. Both lenders and borrowers need to think about the possibility of a deficiency. Both need to look at alternatives to a foreclosure sale, such as mortgage restructuring, reinstatement of the mortgage, redemption or a short sale.

Laws May Help Borrowers

Deficiency judgments may not be allowed, or a homeowner-borrower may not have to pay even if a bank gets a judgment.

Laws Barring Deficient Judgments

In some states like California, antideficiency statutes can bar deficiency judgments in certain cases. Often, deficiency judgments aren't allowed when foreclosure is on a first mortgage used to buy the home (also called a "purchase money mortgage"). 

Antideficiency statutes may bar deficiency judgments in non-judicial foreclosure actions. This is where a lender doesn't have to file a lawsuit to foreclose, and the process is controlled by the mortgage documents and state law.

Check the laws in your state, or talk to an attorney, to see if a lender can sue you for a deficiency judgment.

Bankruptcy Protects the Borrower

Under the Bankruptcy Code, a deficiency judgment is a debt of the homeowner-borrower that can be discharged in a bankruptcy case. However, a lender may still seek payment from your loan guarantor.

The prospect of losing a home is scary enough. But homeowners facing foreclosure need to understand that their financial obligations may not end even when their homes are sold.

Questions for Your Attorney

  • Do we have an antideficiency law in our state?
  • Is there any way I can protect myself from a deficiency judgment if I sign as guarantor on my child's mortgage?
  • Should I file for bankruptcy protection before or after my property is sold at foreclosure?