Protecting Against Deficiency Judgments Through Bankruptcy
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Posted by: Erik Clark
Does Bankruptcy Eliminate Liability for Deficiency Judgments?
It’s a common story in many areas of the country: real estate values have dropped and foreclosures have risen.
Borrowers with little hope of seeing their property values bounce back are still deciding to walk away from their mortgages.
Unfortunately, lenders often have the right to pursue these borrowers for a deficiency judgment. The good news is that bankruptcy eliminates personal liability for a mortgage deficiency.
Deficiency: The Foreclosure Sale Price Doesn’t Cover the Mortgage Balance
A deficiency judgment usually occurs when the foreclosure sale price does not satisfy the outstanding mortgage balance, the lender sues the borrower for the difference and “wins.”
For example, let’s say that a house with a mortgage balance of $500,000 is sold for $300,000 at foreclosure.
The lender then initiates a deficiency lawsuit for the $200,000 deficiency. In most residential mortgages, the borrower has personally guaranteed the loan and is liable for the full amount of the mortgage. The lender sues on the note to obtain a judgment which allows them to come after the borrower’s personal property, wages or other real estate in satisfaction of the remaining debt. If the borrower fails to defend the deficiency lawsuit, the court will enter judgment in favor of the bank, a remedy that often results in wage garnishment or attachment of property.
Bankruptcy Eliminates Personal Liability for Mortgage Deficiencies
Lawsuits like these commonly force consumers into bankruptcy. Filing for bankruptcy eliminates the debtor’s personal liability for the underlying mortgage. In the example above, filing for bankruptcy would prevent the mortgage lender from seeking a deficiency judgment after foreclosure, the remaining mortgage balance would be discharged. If a deficiency judgment had already been entered, the bankruptcy filing would require the bank to stop with all collection activity including wage garnishment.
Don’t Delay if You Own Additional Property
While filing for bankruptcy will eliminate your personal liability for the mortgage deficiency, bankruptcy may not be able to avoid liens placed on your property prior to filing. Bankruptcy does not eliminate security interests in property, liens in place at the time you file will remain after your case closes. For example, if you’ve lost investment property to foreclosure and a deficiency judgment has been entered against you, a subsequent lien on your primary residence may remain even after the bankruptcy. Although judgment liens that impair an exemption can usually be avoided (removed) by motion in a bankruptcy case, Courts are split as to whether a deficiency judgment that results in a lien on real estate can be removed through bankruptcy. Filing prior to the lien attaching is the safest bet.
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Erik Clark is one of the leading bankruptcy attorneys in Southern California who has had the privilege of representing thousands of clients in chapter 7 and chapter 13 bankruptcy cases in the Los Angeles area. Erik has served as the past President of the National Consumer Bankruptcy Litigation Center (NCBLC) and the American Consumer Bankruptcy College (ACBC). His firm, Borowitz & Clark, is committed to using bankruptcy law as a tool for social justice and was one of the first consumer law firms to join the Law Firm Antiracism Alliance.
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