I have been doing short sales for just over 5 years as of this article, the two most resounding questions, based on the course of action as it relates to the foreclosure are as follows:
1. Will I owe the bank money after they foreclose on my on home?
2. If you are able to negotiate a price and buy it for less then I owe, will the bank come after me for the difference?
As a homeowner, that would be a very important question for me as well. Often, when I meet with homeowners, I always explain how the foreclosure process works. If you are not aware of the legal process in your market, you should learn. It is important that you are able to answer this question for the owner when it arises.
When the lender or bank forecloses on the property and they eventually sell the property for less than what was owed, then a deficiency exists with the loan. The deficiency is the difference between what the homeowner owed and the amount the property sold for.
For example, Mary owes $100,000 on her home and the lender forecloses and sells the property for $60,000 at auction. There is a deficiency of $40,000 for which the lender can then sue the homeowner. The key phrase is “can sue. " That is the right of the lender. However, that is a practice that almost never happens but, it is a real concern for the homeowner. In most cases, the homeowner wants nothing else to do with the lender once the property is sold at auction.
If the deficiency judgment is granted, it would appear on the homeowners’ credit report just as any other judgment would appear.
While the second question, on its surface appears to be similar to the first, it really isn’t. That’s because the outcome is different. The homeowner, while they may not be savvy to the short sale process, will want to know what happens to the difference. That is what you agree to buy the property for and the current loan balance on the property. Will they be required to pay the difference? During the short sale process, you can negotiate with the lender to not seek a deficiency judgment against the homeowner.
Some lenders as a matter of policy, will not seek a judgment against the homeowner because they feel they have waived their right by accepting a short sale however, if you can get them to openly acknowledge they will not seek a judgment; the owner will be more than happy.
There is a second issue as it relates to the deficiency and that is the 1099.
The lender will issue a 1099 to the homeowner for the difference. In Mary’s case, the lender will issue her a 1099 for $40,000. This will have to be reported as income Mary had received and thus she will have to pay taxes on the $40,000 as though it was earned income.
Either way, the deficiency judgment can be of great concern to the homeowner. It’s real if the property sells on the courthouse steps. In my dealing with lenders, we have found that they generally will not seek a deficiency judgment because of the hardship.
There are a couple of options that the homeowner has as it relates to the deficiency judgment. In Mary’s case, she could file bankruptcy to address the judgment. Mary could also short sale the deficiency with the lender at a later date. In other words, offer the lender a lesser amount as “payment in full. "
Here is an important note. The lender, if they issue a 1099 cannot then sue for a deficiency judgment. The lender can only pursue one or the other. In other words, Mary can’t receive both a deficiency judgment and 1099 from the lender.
Lastly, as you disclose to the homeowner this important information, you must inform the homeowner about the ramifications of the deficiency and the 1099. It is the homeowner’s decision to continue working with you or not.
It is obviously in the best interest of the homeowner to be proactive and deal with the foreclosure. At least there is a chance that the investor can negotiate away the deficiency before it even becomes an issue.
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Mark Sumpter is an investor who is also an expert in the field of buying and selling pre-foreclosures. Mark’s website http://www.ShortSaleExpert.com offer 52 free coaching tips related to building wealth in real estate investing and short sales.