MacFarlane Real Estate, Inc.

A deficiency judgment is the assessment of personal liability against the seller for the unpaid balance of the mortgage debt when the proceeds of a foreclosure or short sale are insufficient to satisfy the debt. Such liability is typically crushing for a seller who in all likelihood is already facing financial difficulties. Therefore, any seller considering the short sale option or facing foreclosure must examine the potential for a deficiency judgment. California addresses this issue within CA Code of Civil Procedure section 580, et seq.

The crucial determination is whether the loan at issue is considered “recourse” or “non-recourse” debt. See the below definitions:

Non-Recourse Debt

In the event of default by the borrower, the lender is restricted to recovering the property, without any right to proceed against the borrower for any deficiency after sale. The lender is prohibited from seeking any of the borrower’s assets separate from the subject property. Of course, if any fraud, misrepresentation or other illegal acts are discovered on the part of the borrower, exceptions will apply.

In California, debt is treated as “non-recourse” under the following two loan scenarios:

1) when loan is made to purchase residential dwelling of four units or less, where borrower occupies at least one unit; OR

2) any seller carry back financing secured by subject property.

Recourse Debt

In the event of default by the borrower, the borrower may be personally liable for the deficiency and the lender may choose to reach to the borrower’s personal assets such as bank accounts, wages, and any other assets the lender can locate.

Examples of recourse loans are refinancing of existing loans, commercial property loans, or H.E.L.O.C. loans.

Determining whether you may face a deficiency judgment as a result of a potential short sale or foreclosure is an essential analysis. Of course, there are a variety of other important considerations such as potential tax consequences and effects on credit ratings.

Many have heard the latin phrase caveat emptor (translation: “let the buyer beware”). However, in the current real estate market, I find caveat venditor (translation: “let the seller beware”) much more appropriate.

With foreclosure filings and notices of default increasing daily, sellers are desperate for assistance and unfortunately misinformed people–not atypically–are more than willing to serve up poor advice. The intent of this blog entry is intended more so to encourage readers to seek out qualified guidance from established sources, rather than to litter the blogosphere with yet another long-winded real estate agent pep-talk on the market.

I would like to address short sales briefly and make readers aware that there is much more to the process than simply dumping your current debt and moving on with your life. The concept of the short sale is not new, yet with the onslaught of sub-prime mortgages and a lagging economy, short sales have become a hot topic of discussion.

In simple terms, a short sale is the sale of a house in which the proceeds fall short of what the owner still owes on the mortgage. The lender agrees to accept the proceeds of a short sale and may forgive the rest of what is owed.

Now, to the nitty-gritty. If your personal knowledge and advice from others is limited to the above simple definition of a short sale–STOP, consult an attorney and/or tax advisor. You need additional information on tax liability, effects on credit, deficiency releases and potentially many other peripheral considerations. The federal government supplied tax liability support for struggling homeowners through the passing of the Mortgage Forgiveness Debt Relief Act of 2007. This can directly apply to a seller considering a short sale. Of course, the seller must qualify for such relief and be wary–this Act pertains only to federal tax liability. A seller must also seek out what kind of state tax liability he/she may or may not face related to a short sale.

This initial blog entry will be one of many on this topic. I will address in detail many of the factors sellers should consider when weighing the option of a short sale. As always (and especially with today’s ever-changing real estate market), my writings are general discussions and should be read in that light. Each situation is unique and you should always consult your attorney to discuss the details of your circumstances.