Can My Lender Sue Me After a Short Sale?

Homeowners considering a short sale might worry a lender can come after them in court for the loan balance. When a short sale occurs, a property generally sells for less than the original price. This leaves a chunk of missing money between your original loan and the money the short sale received.

For example, if your home loan is $250,000 but the home sells for $200,000 in a short sale, your original loan would have a $50,000 loan balance left.

A lender obviously wants their full money back because their business relies on lending money and receiving the money back with interest. Your lender taking you to court depends on whether you live in a judicial or a non-judicial foreclosure state.

Non-Judicial Foreclosure

A non-judicial foreclosure or “mortgage walkaway trustee sale” is when:

• Your lender forces you to foreclose on your home
• Your lender agrees to a short sale
• Your lender cannot hold you personally responsible for their financial loss, such as the $50,000 used in the example above

Some states have exceptions for borrowers and homeowners who have significant other assets. This could include a homeowner needing to sell cars or a boat to help make up the cost. Generally, homeowners will sell these assets before losing their home.

Judicial Foreclosure

In a judicial foreclosure state, your mortgage company will go to court and do the following:

• Explain to a judge why they want to foreclosure on your property
• Present evidence and argue why this is the best idea
• File a complaint
• File a notice called a “Lis Pendens” which has details about the debt total, why a foreclose is a good idea, and how taking your home is the best security for the loan

The judge will review all this information and make a decision. If they agree with the mortgage lender, they will “grant” the judicial foreclosure.

The next step is the court issuing a judgment against you. This means they will formally order that you pay back the total amount owed on the mortgage payments. At this point, the amount you owe will also include the legal costs of going through the judicial foreclosure process.

One Action Rules

Most states limit the rights of lenders to:

• Foreclose on a property
• Seek a personal judgment against the borrower, which involves a court order

Taking more than one action is limited through laws, commonly called “one-action rule” or “single-action rule.” These rules force creditors to take only one action for the recovery of debt. This means they can’t foreclose on your property, then turn around and say you are personally responsible for the money they lost giving you a loan and the short sale not making enough money.

States that have one-action or single-action rules work with state deficiency-judgment statutes. They can stop or limit a mortgage lender trying to profit from the sale of your real estate property if the price was insufficient to cover your total debt.

Why Would Lenders Agree to Short Sales?

Short sales are a good idea for banks and other lenders trying to:

• Avoid foreclosure
• Take the foreclosed property into their inventory of homes to sell
• Cut their losses by avoiding a lengthy and expensive foreclosure process
• Avoid attorney’s fees, property taxes, and other costs
• Find a less expensive and faster way to get rid of delinquent properties

Based on the benefits above, lenders will generally agree to let the property go in a short sale for a discounted price. Getting a home to sell for fair market value is not common in short sales, so the sale price might be lower than typical real property prices.

Will Lenders Accept the Short Sale as “Payment in Full” for My Loan?

It depends. Your lender can decide that you or your property do not qualify for a short sale. It is never required for a mortgage company or bank to accept a short sale payment to satisfy your loan amount. The company can deny your request without citing a reason.

If this happens, you might need to look at other options, such as:

• Sell your house in a traditional sale
• Declare bankruptcy
• Request a loan modification
• Request a refinance of your home
• Work with a real estate attorney or other professional to file applications for short sales

If your short sale request is denied, you can increase your chances of being approved by your lender if you work with an experienced attorney or other professional who is familiar with how to present your best possible case for a short sale.

Will I Owe Tax on the Deficiency After a Lender Agrees to a Short Sale?

Typically the debt is taxable if someone cancels or forgives the debt. When it comes to your primary residence, there are laws in place that will prevent you from being taxed on:

• Money from discharging debts on your home
• Mortgage restructuring
• Mortgage debt forgiveness during a foreclosure

These rules are from the Mortgage Debt Relief Act of 2007.

Tax Consequences: The Mortgage Debt Relief Act

The Mortgage Debt Relief Act applies to forgiven debt from 2007 to 2012. The government allows exclusions for up to $2 million of forgiven debt or up to $1 million of forgiven debt if married but filing separately.

However, the exclusions don’t apply if the debt discharge is from:

• Services performed for the lender
• Any reason not directly related to a decline in the home’s value
• Any reason not related to the taxpayer’s financial condition

Paying taxes on your debt forgiveness will depend on your state’s tax laws and the applicability of federal laws to your specific circumstances. There may or may not be taxes owed at the state or federal level for debt forgiveness from a short sale.