Deficiency judgments can follow a mortgage foreclosure, leaving the former homeowners on the hook for thousands or even tens of thousands of dollars. A "deficiency judgment" is an order by a court making the debtor personally responsible for the shortfall that occurs when the property is sold in foreclosure for less than the balance owed to the mortgage lender. Although deficiency judgments are rare in Pennsylvania, they can and do happen on occasion. Moreover, because of the common misconception that the sheriff's sale eliminates the homeowner's entire liability for the loan, a deficiency judgment can come as a complete shock to the debtor. Fortunately, it is possible to avoid, eliminate, or reduce deficiency judgments by strategic use of Chapter 7 and Chapter 13 bankruptcy and non-bankruptcy remedies, such as mortgage foreclosure defense.
How does a lender obtain a deficiency judgment? A "deficiency" and a "deficiency judgment" are two separate but related things. A "deficiency" occurs in a mortgage foreclosure when the amount obtained at the sheriff's sale is less than the mortgage balance. A deficiency is essentially unenforceable unless the bank reduces this debt to judgment.
Example: John and Karen owe $175,000 on their home mortgage loan. The home goes into foreclosure and is sold at the sheriff's sale for $165,000. There is a deficiency of $10,000 because the house sold for $10,000 less than the balance on the mortgage loan.
To collect this deficiency, the mortgage lender must file a petition to fix fair market value (a "deficiency action") against the debtor. If the lender prevails, the court will issue a judgment in favor of the lender for the amount of the deficiency and attorney's fees and costs. Deficiency judgments accumulate interest at the post-judgment rate of 6%.
Example: Let's look again at John and Karen from the above example. Their house sold at sheriff's sale for $10,000 less than they owed to the bank, leaving a $10,000 deficiency. The lender wants to collect this deficiency. Therefore, after the sale, the lender files a separate lawsuit seeking a deficiency judgment against John and Karen for $10,000. If the court agrees with the lender, it will issue a deficiency judgment for $10,000, making John and Karen personally responsible for the debt.
How may a lender enforce a deficiency judgment? A lender may attempt to collect on a deficiency judgment the same way it might collect any other judgment. In Pennsylvania, the judgment lender has twenty years to collect against personal property, including bank accounts, household goods, etc.
A deficiency judgment also becomes a lien on the debtor's other real property in the county where the judgment was entered, and the judgments can be transferred between counties. Therefore, a deficiency judgment can be highly problematic if the debtor owns real property in addition to the property in foreclosure.
Quick Note: The potential for a deficiency judgment is one reason that it is not necessarily a good idea to walk away from a mortgage loan without consulting a bankruptcy lawyer or mortgage defense attorney. Although deficiency judgments are not common in Pennsylvania, some circumstances may make one more likely. An attorney can review your situation and give you peace of mind.
What are the limits on deficiency judgments in Pennsylvania? First, deficiency judgments are not automatic. A creditor must file a petition to fix fair market value within six months of the transfer of the deed to the new owner after the sheriff's sale. 42 Pa. Con. St. Ann. § 5522(b)(2). If the lender fails to do so, it cannot obtain a deficiency judgment, and the debt is unenforceable.
Example: The bank foreclosed on Barbara's home, the house was sold at the sheriff's sale on May 1, 2015, and the deed was transferred on June 1, 2015. As a result of the sale, there is a deficiency of $25,000. The bank has until December 1, 2015, to file a deficiency action. If it does not, it cannot obtain a deficiency judgment, and the $25,000 deficiency is unenforceable.
Second, if the lender purchases the property at the sheriff's sale, the deficiency judgment is limited by the fair market value of the house. 42 Pa. Con. St. Ann. § 8103(a).
Example: Ann and Tom's mortgage balance is $100,000. The lender purchases the home at the sheriff's sale for $50,000. The lender then files a petition to fix the value at $50,000. If the court accepts this value, the deficiency would be $50,000 (the balance of the mortgage of $100,000 minus the sale price of $50,000). However, if Ann and Tom can show that the home's fair market value is $90,000, the deficiency judgment is limited to $10,000 (the mortgage balance of $100,000 minus the fair market value of $90,000).
Quick Note: If you fail to answer the lender's petition to fix value, the court may accept the lender's claimed value without question. Moreover, it is not enough to challenge the bank's valuation. You must provide evidence supporting your contention that the value is higher than the bank claims. Therefore, it is crucial to consult an experienced attorney immediately if the lender serves you with a petition to fix value.
What are the limitations on collecting deficiency judgments in Pennsylvania? As with most other civil judgments in Pennsylvania, there are significant limitations to collecting deficiency judgments in this state. For example, there is no wage garnishment in Pennsylvania for this type of debt. Also, if the judgment is against one spouse only, the creditor cannot collect against the joint marital property, including other real property and money in joint bank accounts. (See tenancy by the entireties.) Furthermore, certain types of income and assets are exempt from collection.
When is a mortgage lender most likely to seek a deficiency judgment? Lenders take a cost-benefit approach to deficiency judgments. In most cases, it is not worth the cost and effort to pursue a deficiency judgment in Pennsylvania, given the limitations on collections previously discussed and the fact that most debtors in foreclosure have neither the assets nor the income to pay the deficiency. Deficiency judgments are more likely if the debtor has other real property, substantial assets, or a very high income. Unless the lender believes it can recover a substantial percentage of the remaining balance and cover the significant attorney's fees and cost associated with collecting the deficiency, it will typically forgo the deficiency judgment.
What happens to any second mortgage or line of credit? Generally, only a first mortgage holder will seek a deficiency judgment in Pennsylvania. A lender holding a second mortgage need not obtain a deficiency judgment because any unpaid balance on the second mortgage becomes an unsecured loan upon the sale of the house at the sheriff's sale. The second mortgage holder can sue the debtor and obtain a judgment but must do so within the four-year period set by the Pennsylvania Statue of Limitations.
What can a debtor do to limit or eliminate a deficiency judgment during or after a foreclosure? In addition to the general limitations on the collection of judgment mentioned above, there are many options for dealing with deficiency judgments.
–Negotiate a waiver with the mortgage company. Deficiency judgments are negotiable, both during and after a foreclosure. Sometimes, it is possible to negotiate with the bank to obtain either the complete waiver of a deficiency or a settlement for far less than the balance of the deficiency. Often a settlement can be reached with the bank during a mortgage foreclosure defense, perhaps even a "cash for keys" settlement in which the bank pays you to vacate the property.
–Negotiate a deed in lieu of foreclosure or a short sale. Banks will sometimes accept a deed in lieu of foreclosure, which eliminates the possibility of a deficiency in exchange for signing the home over to the bank. Similarly, a short sale, in which the bank accepts a sale at less than the balance owed, can help you avoid a deficiency. However, both of these options can be difficult and take some persistence.
Quick Note: If you are considering a deed-in-lieu or short sale, it is crucial to have an attorney to review the documents. As a bankruptcy attorney in greater Philadelphia, I have seen questionable deeds-in-lieu and short sale approval letters over the years. Also, there can be tax consequences to both a deed-in-lieu and short sale in some circumstances.
–Challenge the valuation. If the bank has already filed a deficiency action, the debtor can challenge the lender's claimed fair market value. If you can show that the actual fair market value of the house is less than the lender claims, you can reduce or possibly eliminate the deficiency. First, however, you should seek the counsel of a foreclosure defense attorney and keep an eye on the response dates.
–Reopen the judgment. The lender must serve the deficiency action on the debtor. I have seen clients who did not know they had a deficiency judgment against them because the lender failed to serve them. It may be possible to reopen the judgment to raise any defenses or challenge the valuation in such cases.
–File for Chapter 7 bankruptcy. Chapter 7 provides complete discharge of most debt, including a mortgage deficiency. Also, if a deficiency judgment attaches to real property exempt from bankruptcy, it may be possible to avoid (remove) the lien.
Quick Note: In Chapter 7 bankruptcy, debtors who are current on their mortgages have the option of continuing to pay the mortgage without reaffirming the debt. If you do not reaffirm the debt but cannot pay the mortgage down the road (even years after your discharge), the bank cannot obtain a deficiency judgment. However, if you reaffirm the mortgage debt in bankruptcy, the lender can obtain a deficiency. There are other benefits to not reaffirming debts in bankruptcy.
–File for Chapter 13 bankruptcy. Chapter 13 is a payment arrangement whereby you pay back a portion of your debts over 36 to 60 months. Any remaining debt (with a few exceptions) is discharged after your final payment, including a mortgage deficiency. As with Chapter 7, a Chapter 13 debtor may avoid a lien arising from a deficiency judgment that attaches to exempt property.
Quick Note: You need not wait until you are hit with a deficiency judgment to consider bankruptcy. Chapter 13 bankruptcy may help you stay in your home if you file before it reaches the sheriff's sale. Even if the sheriff's sale date has been set, it may not be too late. However, the earlier you seek help, the better. The same applies to mortgage foreclosure defense. It is certainly worth a free consultation with a bankruptcy attorney to explore your options.
–Defend the mortgage foreclosure action. Sometimes, you can challenge the foreclosure before it gets to a sheriff's sale. Mortgage foreclosure defense gives debtors the opportunity to defend against the foreclosure action. In addition, it is possible to reach a settlement with the mortgage lender to modify the mortgage in some cases.
The key to dealing with a deficiency judgment or a potential deficiency judgment is information. Know your options, so you can protect your assets and avoid unnecessary financial damage.