Can the bank sue for a deficiency judgment after foreclosure?

The bank can sue for a deficiency judgment after foreclosure if the borrower owes more than the property is worth.

In many areas of the country the huge number of foreclosures has resulted in a substantial loss in real estate values. It's not uncommon for homeowners to be "upside down" because the value of their property has dropped below what they owe on the property. Because of this, more and more borrowers are considering just "walking away" from their property and allowing the bank to foreclose.

While this may seem the logical thing to do, it's not entirely without risk.

The first negative result will be lasting damage to the borrower's credit. The response I've often heard to this warning is, "My credit is already in the toilet; it can't get much worse!"

The second negative result may be an unexpected income tax bill. If the bank chooses not to pursue the borrower to collect the deficiency, it will probably send the borrower a 1099 form for the amount of the loan which it writes off. Although Congress has recently passed legislation to reduce the impact of this risk, in theory the amount of any forgiven debt is considered taxable income.

The third negative result may be that the bank will sue the borrower for a deficiency judgment. While this hasn't happened often so far, it's still a risk.

Here's how it all fits together:

Nevada has a law called the "One Action Rule." Under this law the lender has to foreclose on the property before it can sue the borrower. If the lender sues first, it loses its collateral.

After the Trustee's Sale (the foreclosure sale), under certain conditions governed by NRS 40.455, the lender can sue if there is a deficiency, that is, if the value of the property on the date of the trustee's sale is less than the amount owing on the loan. The lender has strict rules it must follow in pursuing a deficiency.

1. It has to file the lawsuit for a deficiency judgment within 6 months after the trustee's sale or it loses its right to sue.
2. The value of the property is not governed by how much it sells for at the trustee's sale. The lender must prove the value through an appraiser, and the borrower has the right to present his or her own appraiser's opinion of value.

Changes in 2009 create some protections against deficiency judgments for Purchase Money Deeds of Trust.

The 2009 session of the Nevada Legislature passed a new law - AB471, which is now part of NRS 40.455 - which eliminates the possibility of a deficiency judgment on a deed of trust which is used to purchase the borrower's personal residence. The law applies only to purchases after October 1, 2009. The new law has narrow application. In order for the law to apply the following criteria must be present:

• The lender must be a financial institution.
• The real property is a single-family dwelling and the debtoror grantor was the owner of the real property at the time of theforeclosure sale or trustee’s sale.
• The debtor or grantor used the amount for which the realproperty was secured by the mortgage or deed of trust to purchasethe real property.
• The debtor or grantor continuously occupied the realproperty as his principal residence after securing the mortgage or deed of trust;
• The debtor or grantor did not refinance the mortgage ordeed of trust after securing it; and
• The property was purchased after October 1, 2009.

Changes in 2011 create additional protections against deficiencies for Purchase Money Deeds of Trust.

A major issue for the 2011 Legislature was the continuing high number of foreclosures and the consequent steep drops in value for real estate. Many of the purchases during the early 2000's had 100% financing -- 80% on a 1st deed of trust, and 20% on a 2nd deed of trust. Often, the lenders on both deeds of trust were the same entities.

Under existing law the rights of a lender secured under a junior deed of trust (i.e. a 2nd deed of trust) are subordinate to the rights of the lender secured by the 1st deed of trust. If the 1st forecloses and fails to sell the property for more that what is owed on the first, the security of the 2nd deed of trust is wiped out. Because of the huge drops in real estate values, most 2nd deeds of trust in Nevada were wiped out when the 1st foreclosed.

Under previously existing law, the lender under a sold-out junior deed of trust was not subject to the 6 month statute of limitations under NRS 40.455. Instead of a 6 month time in which to bring a deficiency judgment action, a sold-out junior lien holder had 6 years to file a lawsuit for the deficiency. Likewise, there was no protection for a deficiency action by a junior lien holder even if the junior lien was a purchase money deed of trust.

AB 273 passed by the 2011 Session of the Nevada Legislature, made the following important changes:

• Expanded the anti-deficiency judgment protection to junior purchase money deeds of trust;
• Expanded the anti-deficiency judgment protection for all purchase money deeds of trust to cover not only actual foreclosure sales,i.e. trustees sales, but also to short sales and deeds in lieu of foreclosure;
• Restricted the amount an investor could recover to the difference between the amount the investor paid for the loan (as opposed to the unpaid amount of the loan) and the value of the secured property.

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