What Deficiency Liability is Greater, a Short Sale or a Foreclosure?

It depends, but in California it is most likely you will have less deficiency liability by doing a short sale.

In California, if the foreclosing lender seeks redress with a non-judicial foreclosure (and almost all do), then that lender cannot seek additional recourse for any deficiency.  If, however, the borrower has a second loan, such as a fixed second or a HELOC, and this lender is not the foreclosing lender, the second lender is free to seek deficiency (the difference between what you owe and what the lender is paid) after the fact. This only applies to refinanced funds – lenders cannot seek deficiency if the loan in question was for “purchase money funds”, meaning the loan the borrower took out to purchase the money.

With a short sale, the senior lender takes the majority of the payoff amount and offers a smaller payoff amount to any junior liens.  Sometimes the lenders will reserve the right to seek the balance of money owed in the short sale approval letter.  It is advisable to review these letters carefully, and if at all possible with the counsel of an attorney.  That said, generally it makes more sense to do a short sale than a foreclosure because the junior lienholders get something, whereas in a foreclosure the junior lien holder often gets nothing.

Recent legislation in California has further made a short sale more favorable than a foreclosure in regards to deficiency liability.  Previously, lenders who accepted “short sales” of real property and received less than the full amount of debt owing could pursue their borrowers for the deficiency. While many lenders routinely granted waivers of the remaining deficiency after a short sale such willingness was by no means uniform.  Now if the mortgage holder consents in writing to a short sale on any first liens, the lender  is required to accept the sale proceeds as full payment and to discharge any remaining claims against the borrower.

Alternatively, the Governor vetoed legislation that would have retroactively extended to borrowers who refinance their loans the protection that only original purchase money borrowers receive against deficiency judgments in the event of a judicial foreclosure. This means that the new deficiency protections afforded to individuals who short sale their home are not extended to homeowners who refinance their home and go to foreclosure.

Please call today to discuss this further – 877-647-3911