Borrowers who thought they could walk away from a foreclosure, dust off their jackets and pick up where they left off have been surprised to find their debt continues to haunt them.
That’s because banks are pursuing the balance owed on a property after foreclosure sale.
Before the real estate crisis, banks rarely claimed deficiencies. But that’s not the case anymore. Of the 38 properties sold at the El Paso County Public Trustee’s July 20 foreclosure auction 25 of them or 67 percent had deficiencies.
Those deficiencies aren’t just numbers on a page, they’re real dollars that lenders want back.
A lot of borrowers might not realize or didn’t realize when they went into foreclosure or even short sale that there are two elements to every mortgage — the lien on the property and promise to pay.
And just because the borrowers give up the property doesn’t mean they are relieved of the promise to pay, said Colorado Springs real estate attorney Paul Murphy.
“I’ve had to represent a number of clients recently who have been sued for deficiencies,” Murphy said.
Lawsuits against borrowers appear to be on the rise nationally, and Murphy said they’re becoming increasingly common in Colorado Springs.
Statistics about how common it’s becoming are hard to come by, Murphy said, because a lot of the larger lenders are selling debt to smaller companies. And many of those companies, which will likely pursue that debt, are sitting on the deficiencies until the statute of limitations approaches.
The statute of limitations in Colorado is six years from the first request for payment, Murphy said. It often takes six months to a year to process a foreclosure and get to the sale, which means borrowers should plan on looking over their shoulders for five years after the foreclosure sale.
“Just because a lender doesn’t pursue a judgment right away, doesn’t mean they won’t,” Murphy said.
In many cases, lenders will wait and give borrowers a chance to get back on their feet before pushing for the deficiency.
“If they have just foreclosed on their house, they’re probably pretty close to the bottom,” Murphy said. “If you start pushing for that deficiency, you’ll probably push them to file bankruptcy.”
While bankruptcy can save a borrower from repaying the deficiency, it won’t protect from taxes.
If the lender writes off the debt from the deficiency, it must submit a 1099 forgiveness of debt notice to the IRS, making the borrower liable for capital gains taxes on that money.
Local tax attorney Robert Scranton said he’s had a lot of panicked calls from foreclosed homeowners worried about having to pay taxes on those deficiencies.
“A lot of people freak out about that,” he said. “But there’s no need.”
He said that the same temporary exclusions for capital gains taxes that apply to property sales and transactions apply to foreclosures as well, which means that anyone who lived in their home for two of the five years before a foreclosure will not have to pay taxes on up to $250,000 for a single person and up to $500,000 for a couple.
Those exclusions don’t count for property that wasn’t a primary residence or for commercial foreclosures, though Jack Kerr, market president at First Commercial Bank said businesses that lose property in foreclosure will often have other business losses that will allow them to write off that capital gains on the deficiency.
Banks today don’t tend to forgive debt without some negotiating, Murphy said.
Ed Sauer, president of The Bank at Broadmoor, said that his institution does not normally forgive unpaid loan debt.
“We’re not forgiving debt,” Sauer said. “We’re going after debt.”
Sauer said his bank doesn’t handle a lot of foreclosures, but that it tries to negotiate an agreement with the borrowers when possible.
“Our first response is to sit down and talk to the borrower,” Sauer said. “Hopefully there’s some good communication there. If there’s no communication there’s nothing to do but work through the court system.”
While it makes sense that deficiencies are more common in an economy where home values are declining, one new development in the world of deficiencies is a surprise … Banks claiming small-dollar deficiencies.
Many banks are claiming deficiencies as little as $1,000.
“Generally it doesn’t pay to have a deficiency less than $5,000,” Kerr said, “as most attorneys won’t take the job of collecting. Usually it has to be $10,000-$15,000 for most good attorney firms to take on a job, although some collection firms don’t care what the amount is.”
Historically, Murphy said, banks have not messed with small change. If the deficiency was less than $10,000, they wouldn’t even claim it.
But five of the 25 deficiencies in the July 20 sale were less than $10,000. And three of those were under $5,000.
“They can turn around and sell it to one of these outfits that buy up debt,” Murphy said.
It’s a small enough amount that the borrower might actually be able to pay and the companies might be able to collect on it.
Scranton said the maneuver could banks striking back at borrowers who did not work with them. While small, the judgment will still go on their credit and they will be obliged to pay it eventually if they want to clear their credit, he said.
“One of the quandaries people face if there’s a deficiency, is do they sit and cross their fingers and toes for five years, hoping the bank doesn’t sue,” Murphy said. “Or do they take a proactive approach and try to negotiate a reduced obligation.”