THE DEVIL IS IN THE DETAILS
Absent express language in a short sale agreement releasing the lender’s right to a deficiency judgment, the lender has six (6) years to file suit against the homeowner for the difference between the loan balance and the sale price. A great article in the Nevada Residential Real Property Blog discusses Bank of America’s opposition to giving up its right to sue the homeowner.
Although there exist no official statistics, it is estimated that currently, less than ten (10) percent of Nevada deficiency judgments are pursued. Many lenders will not bother with a deficiency judgment because they know that homeowners in foreclosure are strapped for cash. It costs more in attorney fees and court costs than the lender will ever be able to recover from most borrowers, so what is their incentive to sue for a deficiency? Deficiency judgments are dischargeable in bankruptcy. If the bank gets a judgment against borrowers and tries to garnish wages, the former owners can file a Chapter 7 and have it eliminated, if they meet the other requirements for a Chapter 7 bankruptcy. So even in the worst case scenario, homeowners might be able to avoid wage garnishment.
The right to a deficiency judgment is worth something to the lender. To convince the lender to give up that right, the homeowner must give up something of equal value in return. This article addresses one method of evaluating the right to a deficiency judgment.
Foreclosure tustee sales and short sales each have different lengths of time for which a lender must file suit or loose its right under a statute of limitations law.
NRS 40.455 governs Nevada homes sold at a foreclosure trustee sale:
Deficiency judgment: Award to judgment creditor or beneficiary of deed of trust.
1. Upon application of the judgment creditor or the beneficiary of the deed of trust within 6 months after the date of the foreclosure sale or the trustee’s sale held pursuant to NRS 107.080, respectively, and after the required hearing, the court shall award a deficiency judgment to the judgment creditor or the beneficiary of the deed of trust if it appears from the sheriff’s return or the recital of consideration in the trustee’s deed that there is a deficiency of the proceeds of the sale and a balance remaining due to the judgment creditor or the beneficiary of the deed of trust, respectively.
As such, the lender has six (6) MONTHS after the trustee sale date to file a lawsuit against the homeowner for the deficiency judgment. If six (6) months passes and no lawsuit is filed, the lender loses its right forever and always. Keep in mind the second mortgage is almost always unsecured debt, and the lender has up to six years to sue on the second or third mortgage.
However, if the house is sold through a short sale, the lender has six (6) YEARS to file suit. NRS 1190 governs short sales:
NRS 11.190 Periods of limitation. Except as otherwise provided in NRS 125B.050 and 217.007, actions other than those for the recovery of real property, unless further limited by specific statute, may only be commenced as follows:
1. Within 6 years:
(a) An action upon a judgment or decree of any court of the United States, or of any state or territory within the United States, or the renewal thereof.
(b) An action upon a contract, obligation or liability founded upon an instrument in writing, except those mentioned in the preceding sections of this chapter.
Since the homeowner must wait six (6) years before the statute runs on the deficiency judgment in a short sale, it behooves the homeowner to attempt to negotiate away the lenders’ right at the time of the completion of the short sale.
But how much is that right worth to the lender? For example, assume the there is a $100,000 deficiency judgment as part of the short sale. Perhaps the simplest way to estimate the value of a right to a deficiency judgment is to use the “market value” if it were sold to a debt collection agency. Under that scenario, the lender could package up hundreds of deficiency judgments and sell them to a debt collection agency for ten (10) percent of their face value. Thus, a $100,000 right to deficiency judgment would sell on the open market for $10,000…a rough measure of its value.
Once the value is estimated, to convince a lender to waive its right to a deficiency judgment, the homeowner can offer the following benefits to the lender during the short sale negotiations:
1. A lump sum payment close to the market value of the deficiency judgment (as early in the process as possible, the homeowner should set aside the montly mortgage payments for the purpose of accumulating that lump sum);
2. an agreement to pay the bank a portion of the deficiency over time (the homeowner agrees to a payment plan);
3. the homeowner can waive its right to sue the bank for predatory lending, etc. (a mutual release); and
4. the homeowner could agree to a peaceful transfer of title and property (instead of forcing a trustee sale).
The homeowner, in conjuntion with making an offer of some “benefit” to the lender, can also increase the risk (or perceived risk) of an adverse event against the lender should the lender not waive the deficiency judgment:
1. The homeowner can back out of (or threaten to back out of) the short sale agreement or encourage other parties to back out;
2. if the house is subject to foreclosure mediation, the lender risks court sanctions for bad faith;
3. the homeowner can increase the risk of discharging the deficiency judgment through bankruptcy; and
4. the homeowner can lease the residence under a long-term lease. The lender must honor a “bonified lease” and the lender faces the risk that the rental agreement and/or renter will not be favorable for the lender.
The benefits of the lender agreeing to the deficiency judgment must outweigh the risks and costs- which they almost always will. One caveat though, even if the economic and financial benefits favor the lender to waive the deficiency judgment, the owners of the note or the “investors” may have a strict policy against
any waivers. Further, the lender may be concernced about setting bad precedent if it agrees to waive a deficiency judgment. A waiver may also adversely affect the lenders’ FDIC capital requirements.