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Ask the Real Estate Lawyer - August 30, 2009
By Ilyce Glink and Samuel J. Tamkin
Q: Three years my daughter and her husband bought a house. A year ago, they upgraded to a larger home and kept the first home as a rental. They were barely getting by financially as teachers when she started to have a difficult pregnancy and was put on bed-rest.
With their reduced income, they realize they will not be able to keep both houses. They want to try a short sale on the rental before it goes to foreclosure. They currently are two months behind in their payments.
The first home has been refinanced, and they understand that refinanced loans tend to be recourse loans where the borrowers are personally liable for the debt. Their biggest fear is that the bank will file a deficiency judgment and try to get their teacher retirement funds and come after any other assets they have. What would you recommend they do?
A: In the current economic downturn, thousands of homeowners are struggling. For many, their financial problems are tied to medical problems. I'm sorry your daughter is having problems in her pregnancy.
For most homeowners, whether they own a primary residence or a vacation home or a second home, the documents they signed at their closing or settlement will be quite similar. Most of those documents are standard
If the debt is not paid, the lender has the right to take back title to the property and sell the home to settle as much of the balance owed on the mortgage as possible. The process of selling the home for the balance owed on the mortgage is generally known as foreclosure.
That brief summary is the way the process starts and the way the process ends. But the general rule is that you are personally obligated to repay the debt owed on a home whether or not the sale of the home through foreclosure results in sufficient funds to pay off the debt. If there are insufficient funds to pay off the debt after the home has been sold in foreclosure, there is a deficiency and the lender can sue the borrower for that deficiency. That's the deficiency judgment you are referring to.
But in some states, lenders who hold mortgages on primary residences can't sue a borrower for a deficiency. In other states, lenders can't obtain a deficiency judgment if the company used a trust deed to secure the debt on the property. In a nutshell, the lender's ability to obtain a deficiency judgment is limited in those states, but there are additional practical limitations for lenders.
To obtain a deficiency judgment, a lender must not only foreclose on the home but also have lost money in the process of selling it through foreclosure. The lender may then go back to court and obtain a deficiency judgment against the borrower. Those additional steps - and they may differ from state to state - may cost the lender more money. Lenders have tens of thousands of borrowers (or more, in some cases) in this situation, and they know that spending additional money may not result in more money for them, so they may choose not to pursue a deficiency judgment.
In some parts of the country where lenders have the right to obtain deficiency judgments, the banks aren't getting those judgments or judges are unwilling to grant them. In either case, once the homes are foreclosed, the borrowers don't need to worry about the lender chasing after them for a deficiency judgment.
Now if your daughter attempts to sell her home in a short sale, her lender may try various things to minimize their loss. One of the terms that some lenders insert into their short sale agreements allows them to pursue a deficiency judgment against the borrower.
To avoid this issue, your daughter would have to refuse to sign that document and require them to remove any option for the lender to obtain a deficiency judgment or to keep the balance owed on the debt alive after the short sale.
If your daughter is able to remove any language that would give the lender the right to go after her for the deficiency, she could proceed with the short sale of her home.
Just be aware that the lender doesn't have to agree to the short sale of the home. But if it doesn't, it would then have to proceed to foreclose on the home. The lender would have to decide whether it would get more cash through the short sale of the home or through the foreclosure process.
Given all that, your daughter should know that even if her state allows deficiency judgments, either because the home she is attempting to sell is a second home or rental property or because there is no prohibition on deficiency judgments, the lender won't be able to touch her retirement accounts.
The lender would first have to obtain the deficiency judgment and then would have to go after non-retirement accounts. These days, a lender attempting to go after other assets usually sends borrowers into bankruptcy. That lender will stand in line with other unsecured creditors in the bankruptcy and may end up with pennies on the dollar -- or nothing more than what they originally had.
You should speak with a good real estate attorney who can help your daughter and her husband sort through their various options.
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Samuel J. Tamkin is a Chicago-based real estate attorney.
Ilyce R. Glink's latest ebooks are "Save Your House From Foreclosure" and "The Clutter Collector: How to Get Rid of Clutter Everywhere In Your House," which are available at her Web site, www.thinkglink.com. If you have questions, you can call her radio show toll-free (800-972-8255) any Sunday, from 11 am-1 pm EST. You can also write to Real Estate Matters Syndicate, PO Box 366, Glencoe, IL 60022
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