Deficiency Judgments

A deficiency judgment allows a mortgage lender to recover the difference between the outstanding balance of a mortgage note and the proceeds of a property foreclosure sale. In Florida, a deficiency judgment can also include costs and attorney’s fees. For purposes of the deficiency liability, the foreclosed property “value” is the fair market value on the date of the foreclosure sale auction. The foreclosed house’s value does not depend upon how much a bank ultimately sells the foreclosed property.

How Deficiency Judgments Work

In Florida, a mortgage foreclosure does not automatically result in a deficiency judgment. Homeowners who lose their home in foreclosure will not necessarily remain personally liable for money owed to the lender.

The mortgage lender must file a motion for deficiency to obtain a deficiency judgment against the borrower after the foreclosure sale. The lender will allege the property’s market value on the sale date and the deficiency amount. The homeowner can defend the motion and can contest the lender’s valuation. The court must hold a separate hearing on the lender’s request for deficiency if the homeowner files a defense.

At the hearing, the mortgage lender must 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 a valuation expert witness. The court will not give the mortgage lender a deficiency judgment against the borrower if the court finds that the foreclosed property was worth more than the note balance on the sale date.

A 2013 Florida statute gives the mortgage lender one year after the foreclosure sale to file a motion for deficiency. During the real estate boom before the 2008 recession deficiency judgments were uncommon because increasing real estate values brought home values above the note balance 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. During and after the 2008 real estate recession, few national mortgage service companies with conventional first mortgages pursued deficiency judgments, especially mortgages on owner-occupied homes.

It appears that national lenders prefer to cooperate with upside-down homeowners to keep the homeowner’s family in their home. For instance, Bank of America after the 2008 recession instituted a program called the Cooperative Short Sale Program. The bank paid qualifying homeowners substantial cash to quickly deed over and abandon their home provided the property is maintained in good condition. Second mortgage lenders and private lenders are more likely than first mortgage holders to sue borrowers personally for default on the underlying promissory note.

There has been a significant increase in second mortgage lawsuits against homeowners since the 2008 recession. Banks that made commercial loans to developers or builders almost always file a lawsuit against the individual borrower to enforce and collect upon the promissory note or personal guarantee of a business loan. You should hire an attorney to defend the deficiency claim if a mortgage lender pursues a deficiency judgment. In many cases, an attorney can use procedural defenses and substantive lending law to defeat a deficiency claim, or the attorney can negotiate an acceptable settlement for much less than the total deficiency liability in most cases.

Defending Against a Mortgage Foreclosure Lawsuit

A homeowner has a right to defend a mortgage foreclosure complaint. An effective foreclosure defense will allow the homeowner to explore possible modification of the mortgage loan. It may also give the homeowner leverage to negotiate a release of liability (a “deed in lieu”) or a favorable monetary settlement to satisfy personal responsibility.

Most first mortgage lenders will not aggressively pursue deficiency liability, or if they do seek deficiency, they are not aggressive in judgment collection. Many lenders will offer a release if a homeowner and their attorney are willing to dismiss an otherwise effective foreclosure defense strategy. Some lenders are more aggressive and have a policy of never forgiving personal liability whether or not the lender plans to pursue a deficiency judgment.

An incidental benefit to an effective foreclosure defense is the extension of time it takes for a lender to obtain a mortgage foreclosure judgment and evict the owner. During an extended legal defense of a deficiency action, the homeowner continues their right to occupy the home without making any payments to the mortgage company, or a homeowner may rent the home and accumulate rental income.

A homeowner should continue to pay homeowner association dues during a foreclosure and deficiency action as they become due for various reasons, including the fact that homeowners may be personally liable for HOA dues and assessments. Also, a homeowner should continue homeowner liability insurance during a foreclosure to protect against the liability of home ownership, such as accidents on the property. Most homeowners will not pay real estate taxes during the foreclosure process because there is generally no personal liability for these taxes.

Most people assume that the homeowner defendant will ultimately lose a foreclosure court case. That is not necessarily true. Some attorneys have successfully defended against foreclosure actions. A successful mortgage foreclosure defense enables the homeowner to seek a judgment against the lender for their attorney’s fees. The successful defendant is entitled to attorney’s fees under the standard mortgage agreement and applicable Florida statutes.

Some homeowners and their attorneys have defended foreclosure cases based on the lender’s standing to bring suit. They usually challenge the chain of ownership of the mortgage note from the originating lender through a series of institutional buyers and assignees who took ownership of the note and mortgage through the Wall Street securitization process. The typical mortgage defense asserts that the foreclosing bank cannot bring suit because it cannot show that it properly acquired ownership of the mortgage. This defense usually fails. Banks anticipate this so-called “standing” defense, and most bank attorneys know how to demonstrate bank ownership of a mortgage.

For a time after 2008, successful mortgage defenses were based on evidentiary challenges. If a foreclosure case does not lead to a release or settlement, the matter will be set for an evidentiary hearing. The lender is required to prove it is entitled to foreclose the mortgage. The lender’s proof requires that three essential documents be introduced as evidence: the note, a record of the borrower’s payment history, and an acceleration letter demanding payment in full. The lender must produce a witness to sponsor these documents into the court record.

In the years following 2008, defense attorneys effectively objected to the documents based upon the hearsay rule applicable to business records. This evidentiary defense worked often for a few years, but more recently courts have been more lenient toward the admission into evidence of mortgage documents.

Mortgage deficiency defense became even more difficult after 2021 when Florida changed its standard for evaluating summary judgment motions. The state adopted the stricter federal summary judgment standard. The result is that a mortgage defense attorney needs to demonstrate substantive evidentiary defense to overcome a lender’s motion for an expedited judgment through a summary judgment motion. Successfully defending the foreclosure and beating the bank requires hiring an experienced litigation attorney who is very knowledgeable about the foreclosure process and rules of evidence and the applicable legal precedents.

Income Tax Consequences

Another problem with mortgage foreclosure is possible income tax consequences. The general rule is that the borrower can incur income tax on the amount of debt forgiven when a lender forgives or cancels a debt. When you negotiate a discount on your mortgage to sell your house (a “short sale”), the mortgage lender may send you IRS Form 1099, which tells the IRS that you have imputed income for the amount of the mortgage reduction. You may also incur income tax liability for the deed in lieu of foreclosure that is part of a short sale agreement. The taxable income will be the difference between the property value and the mortgage loan balance on the date you surrender the property to the bank.

A foreclosure may result in the cancellation of debt income depending on whether the bank pursues a deficiency judgment. Suppose the mortgage lender gets a deficiency judgment for the difference between the property value and the mortgage balance on the foreclosure sale date. In that case, there is no imputed income because 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 forgiveness.

In December 2007, Congress acted to prevent many debtors from income tax liability associated with foreclosure avoidance. The Mortgage Forgiveness Debt Relief Act of 2007 stated that homeowners would 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. The Debt Relief Act has expired and no longer protects homeowners from imputed income.

There is an insolvency exception to imputed income from the reduction of mortgage debt. There is no imputed income if a borrower is financially insolvent when they surrender the mortgaged property to the lender, voluntarily or through foreclosure. A borrower who files bankruptcy is presumed to be insolvent, so a bankruptcy debtor cannot suffer imputed income tax liability because the bankruptcy discharges personal liability under a mortgage note. More information on this topic is available from IRS Publication 908 and IRS Tax Form 982.

The tax law permits many real estate investors to offset imputed debt forgiveness income with corresponding tax losses. For example, suppose a lender forecloses on a parcel of income-producing rental property. In that case, the taxpayer may be able to report an operating loss to offset all imputed income from debt forgiveness in the same year for which the mortgage lender issues IRS Form 1099. When a foreclosed property was not income producing but was held solely for future appreciation (for example, vacant land), the deduction from ordinary income of capital losses in excess of capital gain is 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.