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Mortgage Deficiency Collection on Rise

A recent story published in the Washington Post suggests that the collection of foreclosure deficiencies is on the rise. This may signal the start of a new wave of litigation and collection efforts to pursue the debts remaining after the housing collapse. It also means adding insult (a six figure judgment) to injury (a past foreclosure).

A foreclosure deficiency occurs when there is money owed to the lender after a foreclosure. For instance, suppose a borrower “walks away” from an underwater home in 2009 owing $400,000 on a mortgage debt. The bank forecloses on the home in 2010, and then sells it at auction in 2011 for $300,000. The remaining balance owed on the debt is $100,000. The lender (or a subsequent purchaser of the debt) can sue the borrower to obtain a “deficiency judgment.” But that’s not the end of the story. The homeowner may remain on the hook for costs until the bank obtains ownership through foreclosure. Also, there are interest and fees, including attorney fees and court costs, which increase the total debt. In some cases this can be $10,000 or more each year which can turn a $100,000 debt into $200,000 within a mere few years.

The law regarding the collection of foreclosure deficiencies varies from state to state. Presently 40 out of the 50 states permit creditors to pursue a residential mortgage deficiency. In many states collectors are allowed a certain time to sue the debtor after foreclosure, ranging from 30 days to 20 years. Collecting after the judgment can be stretched for more than 20 years with continuing legal fees, costs, and judgment interest.

If the state law allows a mortgage creditor to delay pursuing the borrower for a deficiency judgment, there is little incentive to sue the borrower. A recent government audit found that the recovery rate for foreclosure deficiencies was a mere one-fifth of 1 percent. The lender gains an advantage by waiting for interest and fees to increase, and time for the borrower to “get back on his feet” financially. A lawsuit for a deficiency judgment can be devastating to a person recovering from a foreclosure, and in many cases this lawsuit arrives without warning.

For those sued for a foreclosure deficiency, a six figure judgment is unthinkable. Bankruptcy is one of the few remaining options to escape the pain of forced repayment through garnishments and asset seizures. For most situations, bankruptcy can discharge the mortgage debt for good.