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 the fair market value on the date of the foreclosure sale auction. For this purpose, the house value does not depend upon when and for how much a bank ultimately sells the foreclosed property. In Florida, a mortgage foreclosure does not automatically result in a deficiency judgment.  Just because you lose a property in foreclosure does not mean you will remain personally liable for money owed to the lender.

Mortgage foreclosure deficiency judgment

To obtain a deficiency judgment against the borrower after the foreclosure sale, the mortgage lender has to file a motion for deficiency in which the lender will allege the property’s market value on the sale date 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. 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 a valuation expert witness.  If the court finds that the foreclosed property was worth more than the note balance on the 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 after the foreclosure sale to file a motion for deficiency. During the real estate boom in the prior decade, 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 of the national mortgage service companies with conventional first mortgages pursued deficiency judgments, especially mortgages on owner-occupied homes.

It appears that national lenders prefer to be more lenient and to cooperate with upside down homeowners to keep the homeowner’s family in their home.  For instance, Bank of America 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 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 since the beginning of 2009.  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. 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 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 defense of a foreclosure will give the homeowner an opportunity to explore possible modification of the mortgage loan and may also give the homeowner leverage to negotiate a release of liability (a “deed in lieu”) or a favorable money settlement in satisfaction of personal responsibility.  Most 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 is willing to dismiss an otherwise effective foreclosure defense strategy.  Some lenders 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, the homeowner continues his right to occupy the home without making any payments to the mortgage company, or a homeowner may rent the home and accumulate rental income.

It is generally advisable for a homeowner to continue to pay homeowner association dues as they become due for a variety of reasons, including the fact homeowners may be personally liable for HOA dues and assessments.  Also, a homeowner should generally 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 attorneys fees.  The successful defendant is entitled to an aware of attorneys fees under the standard mortgage agreement and applicable Florida statutes.

Most homeowners have tried defending foreclosure cases on the basis of 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.

More successful mortgage defenses are 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 live witness to sponsor these documents into the court record.

A successful defense finds reasons to deny the introduction of these documents into evidence.  Generally, the defense may effectively object to the documents based upon the hearsay rule applicable to business records.  Most mortgage lenders use “mortgage foreclosure mill” law firms who assign their youngest and least experienced attorneys to foreclosure cases.  These inexperienced attorneys usually do not anticipate, and do not know how to respond to, evidentiary objections.

For these reasons, successfully defending foreclosure and beating the bank requires hiring an experienced litigation attorney who is very knowledgeable not only about the foreclosure process but also about rules of evidence and the applicable legal precedents.

Income Tax Consequences

Attorneys defending against a mortgage deficiency judgment in Florida

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 forgiven.  When you arrange a discount in your mortgage in order 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 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 the foreclosure sale date and the mortgage balance, the lender is not forgiving any part of the loan so there is no imputed income.  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 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.  The Debt Relief Act has expired and no longer protects homeowners from imputed income.

There is an insolvency exception to imputed income from reduction of mortgage debt.  If a borrower is financially insolvent when he surrenders the mortgaged property to the lender, voluntarily or through foreclosure, there is 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 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, 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 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 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.

What to Do Next

We help people go through their assets and income and determine what is at risk of collection from a judgment creditor. We then develop a plan to protect any exposed assets from collection. If you’re interested in protecting your assets from monetary judgment creditors, contact us or schedule an appointment online.

Last updated on June 9, 2020

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