Mortgage Foreclosure Deficiency Judgment

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What Is A Mortgage Deficiency Judgment?

After several years of real estate depreciation many Florida homeowners and real estate investors find themselves owning property worth less than their mortgage balance. Although they accept loss of equity, if any, in property which is foreclosed by their mortgage lender, people are afraid of the personal liability that comes with a deficiency judgment. A deficiency judgment refers to a mortgage lender’s judgment against the borrower for the difference between the outstanding balance of the mortgage note, plus costs and attorneys fees, and the value of the property foreclosed. For purposes of calculating the amount of deficiency liability the foreclosed property value is determined on the date of the foreclosure sale. Value for this purpose does not depend upon when and for how much a bank ultimately sells the foreclosed property. Personal liability from mortgage debt is today a principal reason for asset protection planning.

In Florida, a mortgage foreclosure does not automatically result in a deficiency judgment. Just because you lose a property at foreclosure does not mean you will remain personally liable for money owed to the lender . To obtain a deficiency judgment against the borrower after the foreclosure sale the mortgage lender has to file a motion for a deficiency in which the lender will allege the property’s value and the amount of the deficiency. The homeowner can defend the motion and can contest the lender’s valuation. If the homeowner files a defense the court must hold a separate  hearing on the lender’s request for deficiency liability.

At the  hearing the mortgage lender has to show the court evidence that the property’s value on the sale date was less than the note balance. Evidence of value requires the lender to produce an expert value witness. The borrower can base his own value upon his own appraisal or can use the government’s tax assessed value as evidence of value. The borrower can bring to the hearing his own valuation expert. If the court finds that the foreclosed property was worth more than note balance on sale date the court will not give the mortgage lender a deficiency judgment against the borrower. A 2013 Florida statute gives the mortgage lender one year to file a motion for deficiency. Under the old law a lender could file a new and separate claim for deficiency up to five years after the foreclosure sale date.

What Is Probability The Lender Will Pursue Deficiency Liability?

During the real estate boom in the prior decade deficiency judgments were uncommon because increasing real estate values brought home values above note balances of defaulting mortgages. Additionally, lenders could take back “upside down” properties and hold them until the rising market made them whole. Deficiency liability is a problem in a declining market. Up to this point in the real estate crash few of the national mortgage service companies with conventional first mortgages have been pursuing deficienty judgments, especially mortgages on owner occupied homes.

Many attorneys and other experts have speculated through media publications that first mortgage deficiency lawsuits will increase in the future as lenders resolve foreclosure backlogs and as they sell their deficiency rights to third party investors and collection firms. In fact, it appears that national lenders have decided to be more lenient and to cooperate with upside down homeowners. For instance, Bank of American has a pilot program called the Cooperative Short Sale Program under which the bank will pay qualifying homeowners substantial cash to quickly deed over and abandon their home provided the propery is maintained in good condition.

Second mortgage lenders and private lenders are more likely than first mortgage holders to go after the borrowers by suing for default on the underlying promissory note. There has been a significant increase in second mortgage lawsuits since the beginning of 2009. Banks that made commercial loans to developers or builders almost always file a lawsuit against the individual borrower to enforceand collect upon the promissory note or personal guarantee of a business loan.

If a mortgage lender pursues a deficiency judgment you should hire an attorney to defend the deficiency. In many cases, an attorney can use procedural defenses and substantive lending law to defeat a deficiency claim, and the attorney can negotiate an acceptable settlement for much less than the total deficiency liability in most cases.

Using Chapter 13 Bankruptcy To Modify Mortgage And Avoid Deficiency Judgment

One way to avoid deficiency liability, or to modify your mortgage to avoid foreclosure, is court ordered mediation with your mortgage lender through a new mediation program in Chapter 13 bankruptcy cases. If you file a Chapter 13 bankruptcy in the Orlando division the the federal bankruptcy court will very soon after filing issue an order requiring the lender to participate in good faith mediation to discuss mortgage modification. The HAMP mortgage program was modified this year to eliminate bankruptcy as an obstacle to mortgage relief.

Income Tax Consequences Of Foreclosure, Deficiency, And Short Sale

Another problem with mortgage foreclosure is possible income tax consequences. The general rule is that when a lender forgives or cancels a debt the borrower can incur income tax on the amount of debt forgiveness. When you arrange a discount in your mortgage in order to sell house (a so-called “short sale”) the mortgage lender will cancel part of your mortgage debt and you will receive a tax form 1099 telling the IRS that you have imputed income for the amount of debt reduction. You will also incur income tax liability for a deed in lieu of foreclosure. The taxable income will be the difference between the property value and the balance of the mortgage loan on the date you surrender the property to the bank.

A foreclosure may result in cancellation of debt income depending on whether the bank pursues a deficiency judgment. If the mortgage lender gets a deficiency judgment for the difference between the property value on foreclosure sale date and the mortgage balance the lender is not forgiving any part of the loan. If the bank chooses not to pursue a deficiency judgment, or pursues the judgment unsuccessfully, the borrower may incur income tax liability for debt foregiveness.

In December, 2007, Congress acted to protect many debtors from income tax liability associated with foreclosure avoidance. The Mortgage Forgiveness Debt Relief Act of 2007 states that homeowners will not be subject to income tax from release from mortgage liability if and to the extent the mortgage proceeds were used to buy or improve their primary residence. There is no income tax shelter from foregiveness of mortgage debts for investment property, vacation homes, or mortgages used for businesses or to pay off credit card balances. You should speak with an attorney or CPA familiier with the new law to see if you qualify for income tax protection.

For those borrowers who do not qualify for protection of the new Act there is an insolvency exception to imputed income from the cancellation of mortgage debt. If a borrower is financially insolvent when he surrenders the mortgaged property to the lender voluntarily or through foreclosure there will be no imputed income. A borrower who files bankruptcy is presumed to be insolvent, so that a bankruptcy debtor cannot suffer imputed income tax liability because the bankruptcy discharges personal liability under a mortgage note. More information is available from IRS Publication 908 and IRS tax form 982.

The tax law permits many real estate investors to offset imputed debt foregiveness income with corresponding tax losses. For example, if a lender forecloses on a parcel of income producing rental property the taxpayer may be able to report an operating loss to offset all imputed income from debt foregiveness in the same year that the the mortgage lender issues the Form 1099. When a foreclosed property was not income producing, but was held solely for future appreciation (example: vacant land), the deduction from ordinary income of capital losses in excess of capital gain may be limited to $3,000 per year so that the total loss will have to be deducted over future tax years. You should consult your CPA to determine the tax impact of a mortgage foreclosure on your tax situation. The tax impact of foreclosure is not a legal issue.

Defending Mortgage Foreclosure

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Jon Alper

About Jon Alper

Jon is an attorney focusing on bankruptcy and asset protection in Orlando, Florida.