Decades from now, law books will include a chapter about real estate short-sales and foreclosures. That is because short-sales and foreclosures will affect both the value of properties and the legal rights of parties for years to come. History will prove that mortgage companies did real estate and the public a horrible disservice by making mortgages available in artificial amounts and rates. We already know from the declining price of real estate the immediate market result of distressed sales. But what will be the long-term effect in human terms of open-ended short-sales and foreclosures?
When a mortgage company approves a short-sale, it is not generally waiving a deficiency. When property is foreclosed, banks and mortgage companies still expect to be paid the balance of the mortgage, even though the property usually sells in foreclosure for only a fraction of the original debt.
So what will a lender do with a real estate deficiency? There are those who believe that when the foreclosure nightmare is over, lenders will have had their fill of court action and will withdraw from the battlefield. I have another view. Social conscience did not prohibit lenders from inventing and marketing to the public stated-income loans, loans based on unrealistic appraisals, and progressive-interest-rate loans. Those loans were made by corporate interests motivated by bonuses to insiders and dividends to shareholders. Those motivations have not changed. Neither will social conscience prevent those same lenders from either obtaining judgments and selling those judgments to collectors, or offering a percentage of the unpaid debt to a collector who will then seek a judgment. In either event, there will be deficiency judgments. That’s the reason I urge my clients to negotiate now, even if it requires a little more time and money, for an absolute release in the event of a short-sale or foreclosure.
When land is foreclosed or when a short-sale is approved, unless the lender releases its claim on the entire unpaid balance of the Promissory Note, that claim remains. That claim is called a “deficiency” and the right to obtain a judgment on that deficiency remains for five years after the date of the foreclosure.
A judgment becomes a general lien on all the real property owned by the Defendant. If husband and wife own property, then the judgment becomes a lien against everything they own together. That judgment will also affect every future real estate or banking transaction the debtor attempts. Even if the debtor is discharged in bankruptcy, the bankruptcy will have an effect on the debtor’s credit rating, on the debtor’s ability to buy or sell real estate, and, in general, on every future financial transaction or money account the debtor seeks to make, at least for a while, probably measured in years.
A judgment will last up to 20 years in the public record. That means that during the entire balance of the time during which most investors would be active, their willingness to own and invest will be affected by a judgment if left unpaid. It may be that neither the people involved nor the economy as a whole can afford the dampening effect of judgments held over an entire generation of investors.
There are exemptions from judgments. Corporate judgments may not affect individuals. Judgments against the husband may not affect transactions involving husband and wife. Life insurance and some federal and state retirement programs are exempt from judgments. Nevertheless, a judgment ought not to be suffered by the debtor casually. There are lawyers whose entire specialization is the protection of assets. There is no shame in protecting one’s family or retirement by an honest effort to separate business from personal assets, and to protect those that are personal. There is shame, or should be, in buying more real estate than one reasonably expects to pay for, or in borrowing money that one does not reasonably expect to repay.
It is important to real estate, to business, and to the economy that honest, aggressive, imaginative people can borrow money for real estate and business investment. That cannot happen if debt cannot be predictably collected. Creditors’ rights to enforce judgments are an important part of the collection of debt.
Finally, I wouldn’t want this article to be taken as a condemnation of those who cannot pay their mortgages. Feeding the children is still more important than the mortgage; too many people simply guessed wrong about the economy for any of us to be judgmental. If the choice is between a short-sale, but no forgiveness of debt, or no short-sale, I am still recommending a short-sale when the payment amount threatens the financial existence of the debtor.
But, I am also strongly urging mortgage companies and borrowers to find a compromise and settle the debt amount now (even if it cannot be paid now), rather than the borrower’s head have it hang over until a later day.
While I have said I am not judgmental about the inability to make a mortgage payment, I am judgmental about the approach that assumes all our mortgage debt should simply be forgiven, as if we are entitled to forget we borrowed money.
One of the most destructive long-term outcomes of real estate over-lending may very well be the casual approach which over-lending has created in the individual attitude about repayment of debt.
For now, my best advice to a client is to not blow-off the possibility of a deficiency judgment or its importance. Don’t panic and don’t become despondent, but do understand that a judgment is only insignificant if you intend to become financially insignificant yourself. I will wager that if you intended that, you would not have read this far in this article. Please do not disrespect the effect of a judgment.