Deficiency Judgments: The Dark Side Of Short Sales

Just because you do a short sale doesn’t mean that you get to walk away from your underwater house without any financial repercussions at all.  Yes, you may have heard that a short sale allows you to get out from under the heavy burden of owing more than your house is worth but that’s not always true. You could easily end up having to cover the shortfall anyway – in which case half the benefit of doing the short sale evaporates. (The other half of the benefit is that you get to move even though you can’t pay off the mortgage.)
The mechanism by which your creditors keep you liable for the shortfall in the mortgage balance is called a deficiency judgment. So who ends up with a deficiency judgment and who doesn’t? Well, let me describe two of our recent short sale clients and you guess which one ended up with the deficiency judgment.
Client #1 was underwater by a large amount by most people’s standards. The trick was that they had enough money so that, if they had wanted to, they could have brought sufficient money to the closing table to pay off the mortgage. Doing so would have been extremely painful but, financially, they were in pretty good shape so this was an option. Client #2 was underwater by a much smaller amount but they had absolutely no money to bring to the table. And we hooked up both client #1 and client #2 with the same professional negotiator – an attorney who does nothing but short sale negotiations with lenders.
So who do you think got stuck with the deficiency judgment? Client #2. And the reason? Well, no doubt client #1 got lucky. It’s pretty unusual for someone with substantial financial resources to get off scott free. But client #1 had another advantage that I did not tell you about. They had a sufficient down payment so that they did not have to get mortgage insurance. And in the end it was the mortgage insurer who went after client #2 for the shortfall.
You see…if you don’t have a sufficient down payment to give the mortgage lender a comfortable cushion against default then they need to go out and buy mortgage insurance on your loan, which you pay for. If and when you default the lender goes to the mortgage insurance company to cover any shortfall. The mortgage insurer can then come to you to seek coverage for their loss, depending on the terms of your insurance contract of course.
So in the end the client with substantial financial resources bears no penalty while the client with no financial resources gets stuck holding the bag. But no one every claimed that life is fair. And the other thing to remember about short sales, like most things in life, is that “individual results may vary”.

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