What is a Deficiency Judgment?

Blog Post Image
Real Estate

 


If you are facing foreclosure in Hawaii, you may instead be able to short sale your property
to salvage your credit and settle your debt.

If you are allowed to do so the lender may ask for a deficiency judgment. So what exactly is a deficiency judgment?

The term used by lenders to describe their loss is called a deficiency.

So let's walk through how your lender handles the money that they are owed when a home will be sold as a short sale.

First, the lender can offer forgiveness people choose a short sale over foreclosure mainly to salvage their credit and settle their debt with the lender. The bank can forgive the debt that you owe, however, you plan on receiving a 1099 at tax time.
When a bank sends a 1099 to a borrower, they are reporting their loss to the IRS and its income to you. The 1099 is a cancellation of the debt you owe. And once received, it technically needs to be reported as income and then that becomes
a taxable event. When the lender sends you a 1099, they relinquish their right to pursue any
deficiency against you. But then the problem becomes is now you have to report that as income and you're going to have to pay Uncle Sam at the end of the year. It's all going to depend on your unique situation. So you're going to need to check with your accountant for specifics. A borrower who receives a 1099 that resulted from a foreclosure or short sale can potentially be forgiven from IRS liability if the borrower
is insolvent. Insolvency occurs when an individual has more debt and liabilities than they have assets. In most circumstances, the client involved in the short sale is suffering from financial hardship and may be able to claim insolvency. Let's look at a simple example to make sure we're on the same page.


So in this example, let's say the mortgage that you took out from the lender was $1 million. And over the course of time, you've already paid the lender $100,000. So now we're left with $900,000. We are able to short-sale your
house for $800,000. That leaves a remainder that the lender is owed at $100,000.

So the 1099 form that you're going to receive from the lender will be for $100,000. So using that example, you will be taxed an additional $100,000, unless you are insolvent. As an alternative, the lender can issue the borrower a promissory note for a specified amount to be paid monthly over a number of years. This is a lender's way of getting more money out of the seller which an experienced negotiator can actually address with the lender. If you cannot show financial hardship, then
the bank is more likely to ask you for one of these. These are four likely reasons for a promissory note or a cash contribution.

Number one, the borrower is already strong financially. Number two, the loss to the lender is considered large, usually over 50%. Number three, the borrower is current on their payments. And number four, there's a PMI company involved. The third way the bank may require you to settle your partial or total debt is through a cash contribution paid at closing. Sometimes the lender may ask for a nominal amount of cash at closing in amounts such as $5,000 to cover some of those closing costs. This also tends to be asked if any of the above scenarios are in place. Knowing your foreclosure timeline is extremely beneficial should you find yourself in a position of falling behind on your mortgage payments. While it may be uncomfortable, you must stay in touch with your lender. In all of this, the good news is that the earlier you address this issue, the more options you are going to have. One of the options is to remain in the property until they literally kick you out. For your financial future, You may not want to do that. 

The next option is going through a process called the short sale. This is typically the best option when you need to rid yourself of the property. You'll avoid foreclosure, settle your debt, salvage your credit and be able to begin rebuilding your financial future.

 

If you would like more information on this and would like to speak specifically about your situation please feel free to reach out. If you found this information helpful. Please click and feel free to subscribe to the channel below for more information about real estate and Oahu living.


Thank you!