Deficiency Judgments, Foreclosures & Short Sales

Here’s one of the more recent questions from the Washington Association of REALTORS® legal hotline.  The deficiency judgment seems to be a hot topic again lately.. and another reason why you should seek an experienced agent for your short sale situation. QUESTION:
When can a lender take a deficiency judgment against a seller and, conversely, when is a lender prohibited from taking a deficiency judgment?
First, a deficiency judgment is a court ordered obligation on a borrower to repay money to the lender even though and even after the borrower’s lender foreclosed the deed of trust on the real property. The amount of a deficiency judgment is the difference between what the borrower owed the lender and the sale price of the real property at the foreclosure sale.In Washington state, there is only one way for a lender to take a deficiency judgment against a borrower whose repayment obligations are secured by a deed of trust on real property. The only way lender can take a deficiency judgment is for lender to judicially foreclose the deed of trust. Judicially foreclosing a deed of trust means that a lawsuit must be filed by the lender against the debtor. Before the property can be sold at the foreclosure sale, there must be pleadings filed in the court and hearings conducted. This is not a simple process where notice of the foreclosure sale is given and the property is sold 90 days later at a foreclosure sale. A judicial foreclosure is expensive, time consuming and fairly complicated. As a percentage, very few foreclosures in Washington state, on an annual basis, are judicial foreclosures.


The far more common type of foreclosure is a non-judicial foreclosure. Remember that only judicial foreclosures can result in a deficiency judgment. Accordingly, the vast majority of foreclosures conducted in our state cannot result in a deficiency judgment against seller. Significantly, real property that is used for agricultural purposes must be foreclosed judicially. Agricultural property may not be foreclosed non-judicially. In a non-judicial foreclosure, lender must give notice to seller (and others, such as junior lien holders and occupants of the property) that the loan is in default and how the default can be cured. Thirty days after that notice is given, lender must give another notice setting the foreclosure sale for at least 90 days later. No other notices are required before the foreclosure sale can happen.


In a non-judicial foreclosure, no deficiency judgment can be taken. However, if the property owner had a first position creditor and a second position creditor on title to the property, and the first position creditor foreclosed its deed of trust, the second position creditor (and any other subsequent creditors) can still pursue debtor for the debt owing to those junior creditors, even though debtor no longer owns the property that originally secured the junior debt. In other words, a non judicial foreclosure prevents the creditor whose deed of trust was foreclosed from seeking repayment from debtor of any portion of the foreclosed debt, however, any other debt that was also secured by the property and unpaid as a result of the foreclosure sale, can be sought from debtor by the remaining creditors. In a deed in lieu of foreclosure scenario, the debtor and lender negotiate a settlement in which the creditor takes title to the property from debtor and creditor gives something to debtor in exchange.


What creditor gives to debtor will vary from case to case but it typically involves some reduction in funds owing, such as penalties and interest, and could include a reduction in principal. It is possible that debtor will emerge from a deed in lieu scenario and still owe creditor funds, but if that is the case, it would be the result of a negotiated agreement between creditor and debtor. It would not be a “deficiency judgment”. Note that a deed in lieu of foreclosure is not a likely outcome if there are any junior encumbrances on title because the creditor takes title from the debtor subject to all recorded encumbrances. In other words, the first position lender gives up its first position lien and takes whatever position of ownership is next in line based on all recorded encumbrances. If there are debts recorded against title to the property other than the creditor’s who is agreeing to the deed in lieu, the creditor will not agree to a deed in lieu.


In a short sale scenario, debtor and creditor enter a negotiated agreement where debtor conveys the property to a third party buyer and creditor releases some or all of the debt secured by the deed of trust so that the third party buyer can take clear title to the property. The released debt may or may not remain an ongoing liability for debtor, again, depending on the negotiated agreement between debtor and creditor. If the property was encumbered with multiple liens or deeds of trust, the holders of all of the liens and deeds of trust must agree to release whatever portion of their encumbrance will not be paid by the sale of the property to a third party and may or may not have the ability to pursue the debtor based on their short sale agreement with debtor.


Again, any obligation remaining from debtor to creditor is the resulted of agreement and not a deficiency judgment. There is only one mechanism for a lender to take a deficiency judgment and that is a judicial foreclosure. Nonetheless, there are a variety of ways in which a debtor can emerge from a default situation and continue to owe the creditor or creditors unpaid debt.

 This question was answered by the Washington Association of REALTORS Attorney, Annie Fitzsimmons. The Legal Hotline lawyer does not represent Washington Association of REALTORS® members or their clients and customers.

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