Deficiency Judgment From Foreclosure

I get many questions from clients regarding consequences of a short sale and foreclosure.  Specifically, many people are concerned about the tax burden and the deficiency judgment.  I found this helpful flow chart made by Diane Drain over at www.dianedrain.com.

One thing you will notice is that this chart shows a Trustee’s Sale is different than a Judicial Foreclosure.  Trustee Sales is what happens every day at the court house steps and in law offices.  These are by far the most common form of foreclosure.  The alternative is Judicial Foreclosure.  This is what happens the lender goes through the court room to foreclose.  For the most part, lenders don’t like this route for a couple of reasons.  One is that there is almost no benefit to them, and second, there is a redemption period, and that makes the waters too murky for the lenders.

So what does this table tell us?  Regardless of whether you are the owner occupant or you are an investor, as long as the property is a single family dwelling or duplex and on 2.5 acres or less, you will not have any deficiencies from any lenders if it goes through a trustee sale.  Any junior deeds of trusts get wiped out after a trustee sale.  Please note that these do not wipe out judgments or HOA liens.  The way it has been explained to me is that even if it’s a cash out refi or you bought 10 big yellow hummers, you’re fine as far as deficiency goes.  Uncle Sam will be knocking on your door for sure, though.

Now, if this is a situation where the home is on more than 2.5 acres or is neither a single family dwelling or duplex, then through a trustee sale, the lenders can come after you for the difference.  However, the Arizona Revised Statutes (ARS) state that the lender has 90 days to file, or else they’re out of luck.  We hear 6 or 7 years thrown out a lot, and it is simply untrue.

So what happens if the bank decides to go through a Judicial Foreclosure?  Well as long as the property sits on 2.5 acres or less, the home is single family or duplex, and all the debt is purchase money, you’re safe.  If even one of those is not true, then the distressed homeowner is subject to a deficiency.

So with all those questions answered, we now have to consider short sales.  It looks like anybody doing a short sale needs to ensure that their short sale approval letter states there won’t be any deficiency judgments.   In most of my short sale approvals, the language goes something like “Paid in full for less than the full balance.”

This is a lot of information to digest, so please feel free to comment below or contact me directly for clarification.  As always, I am not an attorney or an accountant.  Please do not make any legal or tax decisions based on the information here.  Please consult a lawyer and tax professional when you are ready to make any type of decision.

For the full flow chart, review the deficiency judgment flow chart.