Definitions:
Deficiency:
A deficiency is the shortfall between the amount of the particular mortgage or trust deed balance owed to the lender and the sum for which the real estate collateral sells on the courthouse steps. For example, if $200,000 is owed and the property sells for $180,000, the deficiency is $20,000.
Deficiency Judgment:
A deficiency judgment is a judgment entered by a court which is equal to the sum of the deficiency and which may be collected from after earnings or assets of the debtor other than the property which is foreclosed.
Judicial Foreclosure:
This is a foreclosure which results from a lawsuit. The borrower does not have any right to cure the default after the lawsuit is filed and must pay the full balance of the debt. The suit is filed in the county where the property is located and the sale is conducted by the sheriff of that county on the courthouse steps.
Non-Judicial Foreclosure:
A non-judicial foreclosure is done without the formality of a lawsuit or a court oversight. A trustee gives a notice of default. The borrower has 120 days to bring all the payments current and reinstate the loan. If the borrower fails, the property can be sold on the courthouse steps by the trustee upon the expiration of the 120 days. The foregoing relates to trust deeds. Foreclosure, or forfeiture, of land sale contracts are slightly different.
Residential Trust Deed:
A residential trust deed is a trust deed on property, up to and including a four-plex, which is occupied (or in the case of a plex, a portion of which is occupied) by the borrower or members of the borrower’s immediate family as a primary residence. Whether or not a trust deed is a residential trust deed is determined on the date the foreclosure is commenced.
Foreclosure Law Frequently Asked Questions:
Question: Can there be a deficiency judgment on the non-judicial foreclosure of a trust deed?
Answer: No. ORS.86.770(2)
Question: Can there be a deficiency judgment on the judicial foreclosure of a trust deed?
Answer: Yes, unless it is a residential trust deed. ORS.86.770(2)
Question: So, does that mean that there will be no deficiency judgment if my residential trust deed is foreclosed, whether judicially or non-judicially?
Answer: Yes. ORS.86.770(2)
Question: So, if the deficiency results from the judicial foreclosure of a non-residential trust deed (for example, a duplex which I own but is not occupied by me or members of my immediate family as of the date the foreclosure commences) can the creditor get a deficiency judgment?
Answer: Yes.
Question: So, does that mean that, if I have a residential trust deed on my property, I don’t have to worry about simply letting the bank foreclose?
Answer: It depends. If there is a second trust deed on the property payable to a different bank, foreclosure of the first trust deed will wipe out the lien of the second trust deed but it will not eliminate the debt. Once the first trust deed is foreclosed, the bank which held the second trust deed still will hold your promissory note and will sue you personally for the balance of the second. If there is no second trust deed, there will not be a deficiency or collection action on a foreclosure of a first trust deed.
Question: Is there some special rule if the same bank created both the first and second?
Answer: Yes. If the same bank created both the first and second at the same time and both the first and second are owned by the same bank (not necessarily the original issuer) on the date of the foreclosure of either of them, the debt of the other trust deed is also uncollectible by statute. ORS.86.770(2)
Question: So, what if I am buying my home on a land sale contract and there is a default which gives rise to a deficiency. Will there be a deficiency judgment?
Answer: In Oregon, a land sale contract (regardless of whether the property is your primary residence or not) can be foreclosed judicially or non-judicially. If the contract is foreclosed judicially, one of several results may occur. Some judicial foreclosures result in a courthouse sale, some do not. If your contract is foreclosed judicially and it results in a courthouse sale, there will be a deficiency judgment if there are not sufficient proceeds to pay off the purchase price plus the attorney’s fees and costs. Likewise, if there is a specific performance decree which results from a judicial foreclosure of a land sale contract (whether the property is your primary residence or not) there will be a judgment for the short fall if the debtor is unable to pay off the contract. There may be circumstances where the court simply directs the property be delivered to the seller without a sale or a decree of specific performance, in which case there will be no deficiency, and therefore, no deficiency judgment.
When a land sale contract is foreclosed non-judicially, the result is that there is no sale on the courthouse steps. Rather, the property is forfeited to the contract vendor. In that case, there is no deficiency, and consequently, no deficiency judgment.
Tax Consequences of a Short Sale or Foreclosure:
The Internal Revenue Code treats relief from indebtedness as taxable income. There is an exception if the debt relief comes from forgiveness in the form of a gift – clearly not the case with institutional mortgage lenders.
The general principle is that, if the bank agrees to forgive some debt as part of the short sale negotiation or if the bank is barred from collecting some of the debt by reason of foreclosure, that portion of the debt obligation is taxable. The income from relief of indebtedness is recognized in the year of debt forgiveness as ordinary income. If the property is investment property or property held for productive use in trade or business so that a capital loss arises by treating the foreclosure as a sale or exchange, the loss may be recovered $3,000 per year against ordinary income or dollar for dollar for capital gains.
A SPECIAL EXCEPTION ARISES FOR PROPERTY WHICH THE DEBTOR HAS OCCUPIED AS A PRIMARY RESIDENCE FOR 2 OF THE LAST 5 YEARS. A similar exception, not addressed here, applies to real property used in trade or business. In that case of a qualified residence, the debtor does not have to recognize any debt relief up to the amount of the debtor’s original purchase money loan and/or improvement loan, as amortized on the date of foreclosure or short sale. If the original loan(s) is (are) refinanced, the same rule applies based on actual amortization. For example, assume debtor buys the property for $200,000 and gets 100% financing and he pays the loan down to $195,000. As the result of a short sale for $180,000, the unrecovered amount is forgiven or, because of a foreclosure sale, the property goes for $180,000 and Oregon law precludes a deficiency judgment. The debt relief is $15,000 but, since the amount realized by the lender plus the amount of debt forgiveness combined do not exceed the debtor’s purchase money loan balance, as amortized, the debtor is excused from recognizing the debt relief as taxable income. On the same facts where the property has not been occupied as the debtor’s primary residence for two of the last five years, the $15,000 is taxable. The same rule would apply if the debtor refinanced (but did not take money out) the debt midstream.
Assume, however, that the debt relief results in a greater recovery to the debtor than the purchase money loan balance (for example, if the debtor borrowed additional funds which were not used to improve the property). Assume that the debtor purchased the property for $200,000 and, either as part of the purchase or on a subsequent refinance, debtor borrowed $230,000 against the property. Assume that the property that qualifies on the 2 of the last 5 years rule. Further assume that, as a result of the short sale or foreclosure, everything over $180,000 is forgiven. In this case, the debtor gets to exclude the $15,000 but must pay ordinary income tax on the $35,000 surplus.
What is the impact on a credit score of foreclosure versus short sale and how many years before you can get another conventional loan?
Although I have asked at least a dozen mortgage loan professionals, no one has given me the exact number of credit score points which results from a foreclosure as distinct from those which results from a short sale.
Benefits of a Short Sale vs. Foreclosure:
If there is only one trust deed on the property, the only possible benefit of a short sale over a foreclosure is reducing the damage to one’s credit.
If there are two trust deeds on the same property from the same bank which were taken out at the same time and both are owned by the same bank (even if not the original issuer) at the time of the foreclosure, the only possible benefit of short sale is reducing the negative impact on one’s credit.
If there are two trust deeds on the same property, each owned by a different lender, the short sale and the related negotiations may result in a less (or no) financial obligation to the second lender after the short sale. If there is a foreclosure of the first and the second is held by a different lender, the holder of the second will undoubtedly sue for the full amount of the second.
Caveat:
The foregoing summary is just that – a summary. It answers general questions. Special circumstances, for example, bankruptcy or lender errors, may give rise to different answers. On each case, an experienced real estate lawyer should be consulted.
Services to Professionals by Dick and the Buckley Law Firm:
As a professional courtesy, Dick and the Buckley Real Estate Practice Group will, without charge, answer general questions about foreclosure raised by a real estate broker or principal broker.
If there is a specific case involving actual individuals and lenders, please be prepared to give us the names of all of the parties so we can do a conflicts check before answering your questions.
We hope, of course, that you will remember us when you and your clients need to hire experienced foreclosure and real estate attorneys. You can reach us at 503.620.8900.
