What Happens to Debt Secured by Real Estate After A Foreclosure (or Short Sale)?
When a property is sold at a foreclosure auction (or short sale) and the proceeds of the sale are insufficient to satisfy the outstanding debt on the property, there may be a deficiency, or an amount of debt remaining for which the borrower may still be personally liable. The amount of the deficiency is generally the difference between the proceeds paid to the lender and the amount of outstanding debt encumbering the property. As a general example, if a borrower owes $200,000 on a property, and the lender nets $150,000 in the foreclosure process, there may be a deficiency in the amount of $50,000.
In Colorado, lenders generally have the right to pursue a borrower for the deficiency amount. Many lenders will make use of standard collection practices, including collection calls and so called “dunning letters” in an attempt to collect a deficiency without incurring the time and expense of bringing a formal lawsuit. These collection practices must comply with the legal protections for debtors set forth in the Fair Debt Collection Practices Act, which provides that debt collectors may not use, among other tactics, harassment, oppressive or abusive conduct, or false or misleading statements when attempting to collect a debt.
1. Deficiency Lawsuits: What to expect
In certain cases, lenders may elect to bring a formal lawsuit to collect a deficiency. Generally, under Colorado law, lenders have the right to pursue a lawsuit for a deficiency for up to six years after accrual of the lender’s claim for the deficiency. There are a limited number of defenses to such lawsuits. One such defense is the argument that the lender bid an unfair or “unconscionable” amount in the foreclosure process. Additionally, often times there are other parties who may share in the liability for the deficiency, but who the lender as not brought into the lawsuit. If appropriate, a defendant in a deficiency suit may want to bring these other parties to share in the liability. Further, some debtors simply cannot pay the amount of the deficiency in which case the defendant may want to consider bankruptcy.
2. What are my options in a deficiency suit?
The following are some options for resolution of a deficiency lawsuit, but is by no means an exhaustive list:
Settlement Negotiations. Many lenders understand that borrowers do not have sufficient resources to fully satisfy the debt. Consequently, some lenders will consider settlement involving a payment plan with payments over time. If the lender will agree to such a payment plan, its terms may vary depending on a host of factors, including, but not limited to the borrower’s income, assets, and hardships, as well as the lender’s internal debt settlement policy.
Bankruptcy. Any borrower facing a deficiency lawsuit should evaluate his or her options as compared to filing for bankruptcy protection. Such a comparison will assist the debtor in understanding the best option available. Further, the specter of bankruptcy can help influence settlement negotiations with a lender.
Defense of the Lawsuit and Counterclaims Against the Lender. Of course, another option for a borrower is to defend a deficiency lawsuit in court. As mentioned above, there are few effective defenses to deficiency suit actions, and these defenses are generally only narrowly applicable. For example, Colorado courts have held that in order to prevail on a claim for “unconscionable bid,” a defense mentioned above, the inadequacy of the bid “must be so gross as to shock the conscience.” Nat’l Canada Corp. v. Dikeou, 868 P.2d 1131 (Colo. App. 1993). This is a high burden to bear in asserting such a defense. It is also important to keep in mind that in certain cases where a lender has acted inappropriately or contrary to Colorado law, a borrower may have certain claims against the lender which can be useful to assert in a countersuit.
3. Other factors to consider
Credit. Of course, a foreclosure or deficiency suit can have an impact on a debtor’s credit. However, there are certain options available that may help lessen the impact on a debtor’s credit from a foreclosure and a deficiency lawsuit.
Tax implications. A foreclosure or deficiency suit may also have certain tax implications. A debtor should always consult with a certified public accountant or other qualified tax professional to fully understand the tax consequences of a foreclosure and deficiency suit. In certain situations, debt (like that in a deficiency suit) that is forgiven can be taxed as income. There are, however, facts that may help mitigate tax liability for such debt forgiveness, including but not limited, to the Mortgage Forgiveness Debt Relief Act.
This article is intended to provide general information and, therefore, should not be treated as legal advice. If you have been sued for a deficiency or have questions about a specific legal issue, nothing will substitute for the advice of a qualified attorney.