Deficiency Judgments And Bankruptcies
You are in foreclosure, or having a car repossessed, and you’re thinking about bankruptcy. Although different kinds of bankruptcies can have different effects on these kinds of situations, none of that matters to you—you want to get rid of the car or the house anyway. Maybe it’s too expensive, or maybe you don’t like it.
So why do you need a bankruptcy? Just surrender the house or car to the lender, and be done with it. Except it’s not that easy, because you could end up owing a deficiency judgment.
What is a Deficiency Judgment?
A deficiency judgment happens when the value of collateral or security is less than what you owe on that collateral or security. When it comes to houses, this is often known as being “upside down.”
Let’s assume that your home is worth $200,000, but you owe $250,000. Even if you surrender the property to the bank, and allow the bank to sell the property at auction, if the property sells for what it’s worth–$200,000—what happens to the balance of $50,000? The answer is that it becomes money you personally owe, in the form of a deficiency judgment.
Discharging Deficiency Amounts
As you can imagine, when talking about high priced items like cars or homes, deficiency judgments can be very significant dollar figures. But the good news is that once the collateral is sold, the deficiency amount is completely unsecured. In other words, it is treated the same way as ordinary credit card debt or medical debt would be. That means it is completely dischargeable in bankruptcy.
Deficiency judgments don’t just happen after foreclosures. They can often happen after short sales. A short sale is when the bank gives you permission to sell your home for less than what is owed to the bank. So, in our example, the bank may give you permission to sell your home for $200,000.
You are patting yourself on the back, thinking you have gotten rid of the property without a foreclosure, and you have washed your hands of it. Little do you know that unless the bank has specifically agreed to do so, the bank can still come after you for the deficiency.
As a general rule, foreclosing banks have one year to get a deficiency judgment. But that’s just to get the judgment. Once they have the judgment, they can enforce it against you (try to collect) for twenty years.
But let’s assume that in your short sale, you have negotiated for the bank to waive the deficiency. Problem solved, right? Well not so fast, because the IRS does consider forgiven debt to be income to you, and you could owe a significant tax penalty for that forgiven money—a problem you wouldn’t have with a bankruptcy.