I have noticed a lot of comments about the possibility of a deficiency balance after a
short sale. I have also received numerous email questions and telephone calls from real
estate investing agents asking about what to do if the bank release does not specifically
state that the short sale is in full satisfaction of the debt.
It used to be that the SMIs would state specifically in the bank release documents various
wording that would indicate that the short payoff is a forgiveness of any deficiency
balance, or that it is in full satisfaction of the debt.
However, this past fall, we’ve noticed a gradual change in the wording, first they would
not specifically state that it is in full satisfaction of the debt, but the SMIs would
generally not permit the servicing lenders to go after the deficiency balance. Now more of
the release documents state specifically that it is not in full satisfaction and they
specifically leave open the possibility of seeking the deficiency balance even though in
fact they do not pursue it.
Historically, short sales and foreclosures generally did not involve a deficiency balance
in real estate investting because most properties in the past appreciated so fast that a
resultant sale would bring in more than the balance on the loan plus all costs. Indeed
many REOs if kept long enough would often appreciate so fast that all a lender needed to do
was keep it for a while and they could get their money out of it. There were many
exceptions of course, but it was not uncommon in certain parts of the country.
Pursuing the deficiency
The policy whether the servicing lender could or would go after the deficiency balance
first starts with the servicing agreement between them and the SMI who owns the loan. I
have seen a number of different terms, with no clear policy, leaving the decision either
with the SMI or the servicing lender or the servicing lender must consult with the SMI.
Next, the policy decision goes through a public relations and political analysis. With the
federal government so actively involved in the explosion of foreclosures, bailout programs,
and attempts to reduce foreclosures, there is presently negative pressure on lenders to not
pursue deficiency balances. There were more than 70 bank failures this year and many banks
are still on the edge, so they are experiencing contradictory pressures to pursue
deficiencies and to leave them alone. This pressure will help determine whether to go
after only the most egregious cases or to expand the criteria.
Finally, the decision for pursuing a deficiency balance involves the nexus between the
capacity of their legal, bankruptcy, and collections departments and the facts of each
case. A certain predictable percentage of their customers will file bankruptcies, so these
entities will determine how many and which customers to pursue for the deficiency.
The customers they are likely to pursue are customers against whom the lenders believe they
may be able to collect. If the servicing lender owns the note, they may be more
aggressive. I recently had a case in which the second mortgage holder, who also owned the
note, refused to permit a release of lien for a widowed man in his late 60’s, medically
retired and dying from asbestos related cancer, with no assets beyond his exemptions, and
living off of exempt medical retirement income. He is judgment proof and therefore
uncollectible, but they pursued him merely because they did not like this debtor.
Normally, though, the decision to pursue is based upon the collectibility of the debtor. A
medical doctor in his 40’s, with a good income who ended up in financial trouble when he
lost business because of mismanagement of the clinic for whom he worked, who has now moved
to a new area and set up practice, can be rehabilitated in a relative short period of time.
The deficiency is large, so they will likely pursue this customer.
However, a factory worker and spouse, one of whom is suffering from a deteriorating medical
condition, who live from payday to payday with a deficiency balance of $30,000 may likely
be left alone. Don’t get hung up on the dollar amount quoted, because each entity will
establish their cutoffs.
How to know when the borrower is in the clear
The current common practice to leave open the possibility of pursing the deficiency balance
does not leave the borrowers hanging out there forever in fear of a lawsuit any moment for
the balance. Each state has laws called “Statutes of Limitations” or “Limitations on
Actions”. These are laws that place a time limit after which the creditor can no longer
sue a debtor for a debt. One state has a statute of limitation for contracts of 6 years.
Other states have shorter or longer periods of time. Even the IRS does not collect tax
debts after 10 years, with exceptions.
However, you will say, 6 years is a very long time. This is true, but there are some ways
to know sooner.
First, if the lender required a Promissory Note for part of the deficiency, it is highly
unlikely that they will seek more. Indeed, if they did, the lender may face some legal
trouble, for which they are fully aware.
Secondly, if a lender is going to seek a deficiency, it most likely will occur within the
first year. Each year, in January, the lenders must issue their 1099s. A 1099 is the form
they use to report to the IRS the amount that has been forgiven in a short sale or
foreclosure. So, if the borrowers receive a 1099 for the deficiency balance, the lender
may be “estopped” thereafter from pursuing the debtors. The lender receives a tax benefit
from the forgiveness, and the borrower may incur a taxable event as a result, so the lender
may be estopped from further action. For most borrowers, that taxable event is not real,
but only potential because the lender does not know if it is or not.
Third, the current practice is to request a promissory note for part of the deficiency. So
it is currently safe to assume, in most cases (there are exceptions), that if there is no
promissory note demanded as a condition to approval, there will not be a deficiency balance
sought.
This is only a guide, and in no event should be relied upon, because there are differences
around the country and with specific lenders and SMIs. I am not providing legal advice,
only general, very general information.
Please note: I have endeavored to provide general guidelines. Because there are a lot of
SMIs, and even greater numbers of servicing lenders, many thousands of varying loan
products, and often different procedures in different states or regions, many of you may
find cases that deviate from the above discussion. Please keep this in mind.
I have noticed a lot of comments about the possibility of a deficiency balance after a short sale. I have also received numerous email questions and telephone calls from real estate investing agents asking about what to do if the bank release does not specifically state that the short sale is in full satisfaction of the debt.
It used to be that the SMIs would state specifically in the bank release documents various wording that would indicate that the short payoff is a forgiveness of any deficiency balance, or that it is in full satisfaction of the debt.
However, this past fall, we’ve noticed a gradual change in the wording, first they would not specifically state that it is in full satisfaction of the debt, but the SMIs would generally not permit the servicing lenders to go after the deficiency balance. Now more of the release documents state specifically that it is not in full satisfaction and they specifically leave open the possibility of seeking the deficiency balance even though in fact they do not pursue it.
Historically, short sales and foreclosures generally did not involve a deficiency balance in real estate investing because most properties in the past appreciated so fast that a resultant sale would bring in more than the balance on the loan plus all costs. Indeed many REOs if kept long enough would often appreciate so fast that all a lender needed to do was keep it for a while and they could get their money out of it. There were many exceptions of course, but it was not uncommon in certain parts of the country.
Pursuing the deficiency
The policy whether the servicing lender could or would go after the deficiency balance first starts with the servicing agreement between them and the SMI who owns the loan. I have seen a number of different terms, with no clear policy, leaving the decision either with the SMI or the servicing lender or the servicing lender must consult with the SMI.
Next, the policy decision goes through a public relations and political analysis. With the federal government so actively involved in the explosion of foreclosures, bailout programs, and attempts to reduce foreclosures, there is presently negative pressure on lenders to not pursue deficiency balances. There were more than 70 bank failures this year and many banks are still on the edge, so they are experiencing contradictory pressures to pursue deficiencies and to leave them alone. This pressure will help determine whether to go after only the most egregious cases or to expand the criteria.
Finally, the decision for pursuing a deficiency balance involves the nexus between the capacity of their legal, bankruptcy, and collections departments and the facts of each case. A certain predictable percentage of their customers will file bankruptcies, so these entities will determine how many and which customers to pursue for the deficiency.
The customers they are likely to pursue are customers against whom the lenders believe they may be able to collect. If the servicing lender owns the note, they may be more aggressive. I recently had a case in which the second mortgage holder, who also owned the note, refused to permit a release of lien for a widowed man in his late 60’s, medically retired and dying from asbestos related cancer, with no assets beyond his exemptions, and living off of exempt medical retirement income. He is judgment proof and therefore uncollectible, but they pursued him merely because they did not like this debtor.
Normally, though, the decision to pursue is based upon the collectibility of the debtor. A medical doctor in his 40’s, with a good income who ended up in financial trouble when he lost business because of mismanagement of the clinic for whom he worked, who has now moved to a new area and set up practice, can be rehabilitated in a relative short period of time. The deficiency is large, so they will likely pursue this customer.However, a factory worker and spouse, one of whom is suffering from a deteriorating medical condition, who live from payday to payday with a deficiency balance of $30,000 may likely be left alone. Don’t get hung up on the dollar amount quoted, because each entity will establish their cutoffs.
How to know when the borrower is in the clear
The current common practice to leave open the possibility of pursing the deficiency balance does not leave the borrowers hanging out there forever in fear of a lawsuit any moment for the balance. Each state has laws called “Statutes of Limitations” or “Limitations on Actions”. These are laws that place a time limit after which the creditor can no longer sue a debtor for a debt. One state has a statute of limitation for contracts of 6 years. Other states have shorter or longer periods of time. Even the IRS does not collect tax debts after 10 years, with exceptions.However, you will say, 6 years is a very long time. This is true, but there are some ways to know sooner.
First, if the lender required a Promissory Note for part of the deficiency, it is highly unlikely that they will seek more. Indeed, if they did, the lender may face some legal trouble, for which they are fully aware.
Secondly, if a lender is going to seek a deficiency, it most likely will occur within the first year. Each year, in January, the lenders must issue their 1099s. A 1099 is the form they use to report to the IRS the amount that has been forgiven in a short sale or foreclosure. So, if the borrowers receive a 1099 for the deficiency balance, the lender may be “estopped” thereafter from pursuing the debtors. The lender receives a tax benefit from the forgiveness, and the borrower may incur a taxable event as a result, so the lender may be estopped from further action. For most borrowers, that taxable event is not real, but only potential because the lender does not know if it is or not.
Third, the current practice is to request a promissory note for part of the deficiency. So it is currently safe to assume, in most cases (there are exceptions), that if there is no promissory note demanded as a condition to approval, there will not be a deficiency balance sought.
This is only a guide, and in no event should be relied upon, because there are differences around the country and with specific lenders and SMIs. I am not providing legal advice, only general, very general information.Please note: I have endeavored to provide general guidelines. Because there are a lot of SMIs, and even greater numbers of servicing lenders, many thousands of varying loan products, and often different procedures in different states or regions, many of you may find cases that deviate from the above discussion. Please keep this in mind.
When it comes to commercial real estate, it is clear that there is a lot of potential. After all, any type of real estate deal has the potential to change your life. With commercial real estate, though, everything is bigger and better.
When it comes to commercial real estate, it is clear that there is a lot of potential. Any type of real estate deal can possibly change your life. Of course everything is bigger and better when you are dealing with commercial real estate.
There is clearly lots of potential in commercial real estate. Real estate deals in general can possibly change your life. With commercial real estate, though, everything is bigger and better.
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I have noticed a lot of comments about the possibility of a deficiency balance after a short sale. I have also received numerous email questions and telephone calls from agents of 
