Understanding Foreclosure: What is a Deficiency Judgment?

By Karen Lawson
Mortgage Credit Problems Columnist

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Many homeowners are facing foreclosure of their mortgage loans due financial hardship and inability to sell their homes.  In states that allow deficiency judgments (all except CA and OR as of this writing), your lender can sue you for losses resulting from foreclosing on your mortgage.  Any judgment awarded the lender in this situation is called a deficiency judgment.  Is this likely to happen? Maybe not and here's why.

Your Bad Credit and Your Mortgage Company's Bottom Line

Most people lose their homes to foreclosure due to financial problems. They may have lost their jobs or have other financial problems, and their homes are worth less than they owe, making it impossible to sell in time to prevent foreclosure. Lenders use foreclosure as a way to recover losses when homeowners don't make their mortgage payments, and in many cases lenders still lose money.

To foreclose on a mortgage loan, lenders have to go through a legal process that takes time and incurs additional charges for legal fees and property management. In the meantime, they're not collecting mortgage payments, and perhaps you've allowed your home to fall into disrepair. Worse, you may have moved out, and your former home could be vandalized by intruders. This further reduces the value of your home, and the chances that your lender will be able to sell it for enough to recover their losses.

Most mortgage lenders elect not to pursue deficiency judgments due to the small probability of collecting awarded amounts from homeowners who've lost their home due to financial problems.  To do so creates additional legal fees and takes time. Collecting the amount awarded is typically difficult if not impossible when the homeowner no money. If your mortgage is in foreclosure, and you live in a state allowing deficiency judgments, don't assume you will have to pay. If, however, you fall into that group of homeowners who let the house go as an investment decision, or if it appears that you made any attempt to defraud the lender, or if you have the resources to pay, you may find yourself owing your lender big bucks.

Foreclosure, Deficiency Judgments and Bad Credit

Mortgage foreclosure is a legal process that is a matter of public record. A foreclosure can appear on your credit report for up to ten years, and is worse than a bankruptcy on your credit score. In addition, Freddie Mac and Fannie Mae, the country's two largest sources of mortgage financing, claim that borrowers who walk away from mortgages will be ineligible for financing from them for at least 5 years and will have to put up at least 10% to get a new loan. Freddie officials also state that they will aggressively pursue deficiency rights in an attempt to halt the trend of homeowners walking away scot-free.

At best, you'll be able to get a bad credit mortgage loan that may have high rates and fees. At worst you will have to repay your lender the cost of the foreclosure. Lenders' ability to pursue deficiency varies according to state law. If you have questions about deficiency judgments in your state, please consult a real estate attorney or legal aid organization.

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