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Solutions for “Promissory Notes” and “Deficiency Judgments” in Short Sales and Foreclosures.

The issue “Will I have to pay the bank the difference between what I owe and the final sales price of my property?” should be on every homeowner’s mind contemplating a short sale. There is a qualified yes and no to your question. Don’t worry; I’ll explain everything in plain English.

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Let’s start with a glossary:

If the proceeds from a foreclosure sale are insufficient to cover the remaining balance on a mortgage, the lender can seek a deficiency judgment against the borrower. It’s an absolute judgment; the other party is suing you. Therefore, the borrower is responsible for repaying the loan balance that exceeds the selling or auction price of the collateral. Only if the lender initiates a Judicial Foreclosure (essentially suing you for the difference) may legal action be taken against the borrower. Remember that in many instances, the junior lienholder can still seek a deficiency judgment even after a Non-Judicial Foreclosure. This information can be gleaned from the loan’s original paperwork or the specifics of the lender.

Problems such as Unsafety Concerns and Deficiencies occur when the proceeds from the short sale are not enough to cover the remaining balance on the mortgage. Deficiencies typically manifest as:

a. Forgone in exchange for monetary compensation

A promissory note is issued to cover a shortfall or proportion of the balance.

c. Collected after the sale as unsecured notes; in other words, they cannot secure the lien on any other assets (since you’ve already sold the collateral property) without first filing suit. A “deficiency judgment” against you in court by the lender, PMI, or collections agency still does not guarantee that you will have to pay anything. Lenders typically won’t sue borrowers since it’s more expensive than keeping the loan unsecured. While many lenders “reserve the right to pursue the deficiency,” in practice, the 1099 (tax on sale) for the poor balance (which they will charge off) is more likely to replace the unsecured note. Most homeowners are exempt from paying this tax under the Mortgage Forgiveness Debt Relief Act of 2007 (MFDRA).

I Believe I Have Received a Deficiency Invoice/I Believe I Am Being Pursued a Deficiency Judgment: You shouldn’t worry. Debt negotiation experts can help reduce or eliminate unsecured notes and deficiency judgments accrued due to a short sale or foreclosure.

A promissory note, also called a “promise to pay,” is a type of unsecured note and a contract between a lender and a borrower in which the borrower promises to pay the lender the difference between the amount due and the real estate sales price. The borrower must agree in writing for this to be binding, typically delivered at the time of sale. After the sale, these notes can also be renegotiated.

Second, allow me to outline the many benefits of staying out of foreclosure.

Most foreclosures in Washington state will be non-judicial, meaning the lender cannot sue you for any shortfall. Although judicial foreclosures are uncommon in Washington, some Washington-based lenders (such as BECU) go through with them, leaving debtors potentially responsible for paying a shortfall judgment.

The primary reason we recommend a short sale over foreclosure is that most borrowers will be able to get another mortgage within two years after conducting an SS, while a foreclosure (whether non-judicial or judicial) will prevent you from getting a mortgage for at least five years and will do significant damage to your credit. Since homes sell at highly discounted prices at foreclosure auctions, the shortfall (or tax repercussions), if it is collectible, will be substantially higher in the event of foreclosure than in an SS.

We also recommend SS since promissory notes and post-sale deficiency judgments are usually up for discussion. The shortfall can often be reduced during negotiations (for example, from 10% to 0% for a Bank of America HELOC credit). The lender may forgive the debt in exchange for a little payoff or an affordable payment arrangement with the borrower. There are two primary considerations here: First, the power of the negotiator Policy of the lending institution and the sort of loan being sought. The buyer may even be asked to cover the shortfall in some cases.

Again, an SS is better than a foreclosure on your credit report if the lender decides to go after a deficit. Remember that it is unusual for the lender to pursue the debt; thus, the unsecured note will likely be replaced with a Form 1099 from the Internal Revenue Service for taxes payable on the sale. To determine if you are free from this tax, consider the Mortgage Forgiveness Debt Relief Act of 2007.

In addition, if the lender continues to pursue the residual shortfall after the SS, the deficient amount can be further negotiated with the help of an experienced debt negotiation professional. It’s important to remember that there are some instances in which the lender will not approve an SS unless the homeowner agrees to sign a promissory note for the total amount of the difference. Recently, we’ve learned that BECU won’t support most of their SS unless the homeowner signs a promissory letter for the entire amount (although we’ve been able to negotiate these down to a far smaller amount than the shortfall).

In these cases, hiring a professional short-sale negotiator is highly recommended to negotiate the remaining balance as aggressively as possible before the SS and then have a debt negotiation specialist cover the costs after the SS. Before deciding to declare bankruptcy, you should look into these alternatives.

Question 3: “On an SS, will I have to pay the bank the difference between what I owe and the final sales price of my property?” Let me answer this question in the simplest ways possible.

As we’ve already established, a lender can require you to sign a promissory note for the amount you owe to get an SS, and they won’t give you one unless you agree to pay the difference or explain their “right to reserve to pursue a deficiency” in writing. It may be in your best interest to have your SS negotiator reduce the balance as much as possible before the SS and then have a debt negotiation specialist reduce the balance even further after the SS (if the deficiency is pursued by the lender/PMI/collections agency).

In a short sale, the deficiency may be reduced to an amount that can be paid or even waived entirely. If a home is sold for $350,000, but the borrower still owes $500,000, a skilled negotiator might be able to convince the lender to accept $350,000 as full payment (in exchange for a payoff or, in some cases, a payment arrangement) and drop any further collection efforts. This means the homeowner can abandon their SS (albeit they may owe taxes to the IRS on the difference, from which most homeowners benefit under the Mortgage Forgiveness Debt Relief Act of 2007). A negotiator can achieve this goal by showing the lender how much money they stand to lose if the loan is not repaid and the property is lost to foreclosure or bankruptcy. The negotiator will give market data, a financial comparison sheet, etc., to demonstrate that it is in their best interest to move forward with the SS.

There are more than 158 responses to this article. Visit Short Sale & Foreclosure Deficiencies to read the original article and find answers to frequently asked questions.

Short Sail Solutions, LLC, founded by SeattleShortSaleBlog.com author Kevin Kim, is one of the largest teams of short-sale negotiators in the US, having offices in 13 different states. In addition, he established http://ShortSaleBlogRing.com, a hub for real estate agents interested in capitalizing on the short sale specialty in their local market and beyond.

linda