Examples of How US States deal with Shortfall/Deficiency Judgments

The second indirect incentive used to give banks a reason to sell for a market price in the United States is that if they do not do so, they will not be able to obtain a “deficiency judgment”. Deficiency judgments, in states in the US where they are legal, may be granted in cases where a bank has sold a property for less than the amount of the loan. To regain the difference, it is necessary for the bank to approach a court with a separate application after the sale in execution, where it  seeks to obtain the right to pursue the debtor for the difference between the amount raised at the auction and the amount of the loan (if higher). Effectively, there is thus court supervision of the amount the bank sells for. If it fails to sell for a fair market price, the court will, in most states, not allow the creditor to pursue for the amount remaining. Thus, across a very varied US practice, the unifying principle is that there is a strong incentive for the bank not to sell properties for significantly less than what they are worth. In England, in contrast with the US but the same as South Africa, the bank automatically receives the right to the ‘deficiency judgment’ or ‘shortfall’

In the US, there are two types of legal bond systems: judicial and non-judicial.[1] some states (twenty one in total)[2] use mortgages and thus usually judicial process for foreclosure.[3]  Other states (twenty nine)[4] use deeds of trust and thus usually a non-judicial process[5] for foreclosures.[6] All fifty states allow judicial sales, so non-judicial states, in fact, allow for both methods[7]– they pass a statute to allow for this non-judicial method to be used in addition to the judicial method.[8] However, states that follow the title (trust-deed) theory of mortgages typically allow non-judicial foreclosure procedures, which are fast, but do not allow deficiency judgments[9]. In non-judicial foreclosures there is no court order or hearing required. States that follow the “lien theory”[10] of mortgages require judiciary foreclosure procedures, which are slower but allow for deficiency judgments against the debtor. In continental European countries and other civilian systems[11] only allow for judicial procedure. In these systems deficiency judgments are usually allowed.

The following example illustrates the principle of deficiency judgments:

If the total debt is $200,000 and the buyer  bids $150,000 at the foreclosure sale and purchases the property, the deficiency is $50,000. Generally, this means the lender could (in some states) file a lawsuit to get a deficiency judgment for $50,000 and then collect that amount from the borrower. However, if the court determines that the fair market value of the property is really $180,000, the lender could only obtain a deficiency judgment in the amount of $20,000.

Laws with respect to deficiency judgments vary from state to state.[12] In some states, they are allowed within a certain time period commencing from the actual sale, including Arkansas (within 12 months) and Ohio (within 2 years). Other states (such as Arizona, California and Oregon) prohibit deficiency judgments on most residential properties[13]. In the case of Iowa and Montana, the process for obtaining a deficiency judgment is so costly in time or money that many banks do not perceive that pursuing such a judgement is worth the cost.[14]

In Oregon and California, deficiency judgments are not allowed in any (non-judicial) circumstances. Over the years, most foreclosures in Oregon have been non-judicial; however, deficiency judgments are allowed in judicial foreclosures, but not in foreclosures of residential trust deeds.[15] In other words, to all intents and purposes, deficiency judgments will not be granted in Oregon to the vast majority of home owners. The situation is similar in California, where it is illegal for lenders to pursue debtors for any deficiency resulting from selling the property for less than the amount of the bond.[16] In Montana[17], deficiency judgments are not allowed on residential mortgages.[18] Effectively, deficiency judgments are few and far between in Montana.[19] Likewise, most residential foreclosures in Washington are non-judicial and thus deficiency judgments are not allowed following non-judicial foreclosures[20].

In North Dakota,[21] deficiency judgments[22] are not allowed if the property is residential.[23] Thus, most families are protected against their bank selling their property for less than it is worth and then pursuing them for the difference.[24] Similarly, in Nevada, when a bank seeks a deficiency judgment against debtors, the amount of the judgment is limited.[25] In addition, as with most if not all states where deficiency judgments are allowed, there needs to be a court hearing to establish if the property has been sold for fair market value. Only then can the lender pursue the borrower for the balance on the loan. Deficiency judgments are therefore not allowed in all situations in Nevada.[26] Ultimately, in a conventional mortgaged property for a single family that are living there, no deficiency judgments are allowed at all, even if it has been sold for a fair market price.[27] Wisconsin and New York[28] follow the same principles.[29] Similarly, in Idaho,[30] deficiency judgments are limited to the difference between the total amount owed to the lender and the fair market value of the property at the time of sale. [31] Clearly then banks have strong incentives in these states to sell the property for the market price. If they don’t they will not normally be able to claim the funds back from the debtor.

There are variations to this practice. Although the majority of foreclosures in New Hampshire are non-judicial,[32] there is a slightly different test.  In Delaware, the amount of the deficiency judgment will generally be the difference between the total debt and the foreclosure sale price, as with other states. However, if the borrower believes that the high bid at the foreclosure sale is grossly disproportionate to the fair market value of the property, s/he may request that the court set aside the sale or limit the amount of the deficiency judgment.[33] Long ago, the Delaware[34] case discussed above of Girard Trust Bank,[35] a minimum of 50% of the value was established. In Georgia, a non-judicial state, in order to get a deficiency judgment certain procedures must be followed.[36] The court will then have a hearing to ensure that the sale price is at least at fair market value.[37]

The South Carolina[38] approach to preventing banks selling people’s houses for less than they are worth  works somewhat differently with a rigorous procedure as to valuations[39]  but the same principle applies. Texas law has a procedure allowing the debtor to offset an amount against the deficiency if the property is sold for less than market[40]. If the bank has sold it for less than that, then it is the bank that will bear that loss. Finally, Texas law does not allow deficiency judgments at all following the foreclosure of a home equity loan.[41]  In such loans the debtor will never be responsible to pay back when the bank sold his or her house for less than what s/he owed.

Amongst the wide variety of practices in the United States, the common thread is that banks are incentivised not to sell the house for less than it is worth because they will not be able to claim back the difference from the borrower if they do.


[1] Both systems are present in the United States non judicial in some states, judicial in all. Judicial is normal in Europe.

[2] Krebs “British Cures for American Foreclosure Woes: A Comparative Analysis of Foreclosure Law in the United States and United Kingdom “ Chi.-Kent J. Int’l & Comp. L. Vol. XV p10.

[3] This is this system we are familiar with in South Africa

[4] Krebs “British Cures for American Foreclosure Woes: A Comparative Analysis of Foreclosure Law in the United States and United Kingdom” Chi.-Kent J. Int’l & Comp. L. Vol. XV p10.

[5] http://www.nolo.com/legal-encyclopedia/how-foreclosure-works-30066-2.html.

[6] These states are relevant for our analysis as they usually do not allow deficiency judgments. This means we have a control group to compare with states that do allow deficiency judgments.

[7] http://www.realtytrac.com/real-estate-guides/foreclosure-laws/ ;

[8] http://www.law.cornell.edu/wex/table_property .

[9] As we discussed earlier, a deficiency judgment is a judgment that allows the bank to pursue the creditor for any balance remaining when the house has been sold in execution. In other words, if the bank sells the property at auction for less than the amount of the bond, the bank is permitted to reclaim the difference from the borrower

[10] This phrase is the US description of the system roughly equivalent to our own system in South Africa. The phrase is not to be confused with liens in South African law.

[11] Such as South America.

[12] http://www.nationsds.com/summary-foreclosure-laws-state/ .

[13] Or on “purchase money” mortgages A “purchase money” mortgage is where the buyer doesn’t qualify for a bank mortgage and the seller effectively grants him the mortgage. It is also called seller financing or owner financing.

[14] http://www.nolo.com/legal-encyclopedia/whats-the-difference-between-recourse-nonrecourse-loan.html .

[15] Or. Rev. Stat. § 86.770, 705. A “residential trust deed” in Oregon refers to a trust deed on property that, at the time the foreclosure is started, is residential, occupied by the borrower or s/he is a principal residence, and consists of four or fewer residential units

[16] Cal. Code Civ. Proc. § 580e. This law applies to all property under four units, thus the vast majority of residential housing stock. Other lien holders are also not able to pursue other debts owing if they agreed to a short sale It is also prohibited for the bank to make as a condition of the short sale that the debtor signs a contract promising to pay in additional funds.

[17] A non-judicial state using trusts

[18] After a non-judicial foreclosure of a trust indenture or in a judicial foreclosure of a trust indenture for an occupied, single-family residence See First State Bank of Forsyth v. Chunkapura, 226 Mont. 54, 734 P.2d 1203 (1987); Midfirst Bank v. Ranieri, 848 P.2d 1046 (1993).

[19] http://www.nolo.com/legal-encyclopedia/deficiency-judgments-after-foreclosure-montana.html

[20] Wash. Rev. Code § 61.24.100 They are allowed in judicial foreclosures, but these are the minority. It is interesting to note that that banks prefer to pursue the non-judicial route due to its speed rather than pursue deficiency judgments. Deficiency judgments are possibly in all states through the more laborious judicial route but banks use the non judicial route and forego the chance of deficiency judgments.

[21] Where foreclosures are judicial,

[22] N.D. Cent. Code §32-19-03.

[23]For  owner-occupied, one to four units, and 40 acres or less.

[24] Even in other types of properties the usual rule applies about the bank being limited in their claim if they sell the property for less than it is worth. Thus, in these other properties, “the amount will be limited to the difference between the amount of the debt and the appraised value.”http://www.nolo.com/legal-encyclopedia/deficiency-judgments-after-foreclosure-north-dakota.html .

[25] In a similar way to the usual: to the lesser of:t he difference between the total debt and fair market value of the home, or the difference between the total debt and foreclosure sale price Nev. Rev. Stat. § 40.459.

[26] Nev. Rev. Stat. § 40.457.

[27] As from October 1, 2009. (Nev. Rev. Stat. § 40.455).

[28] N.Y. Real Prop. Act. Law §1371.

[29] Wis. Stat. § 846.165.

[30] Which is non-judicial,

[31] Idaho Code Ann. § 45-1512, § 6-108.; http://www.nolo.com/legal-encyclopedia/deficiency-judgments-after-foreclosure-new-york.html.

[32] However, New Hampshire foreclosures can also be judicial and go through the state court system.

[33] Girard Trust Bank v. Castle Apartments, Inc., 379 A.2d 1144 (1977).

[34] Arizona also has a law pending to prohibit deficiency judgments in a similar manner, but the bills has not yet, at the time of writing, been passed into law

[35] Girard Trust Bank v. Castle Apartments, Inc., 379 A.2d 1144 (1977).

[36] “To be eligible for a deficiency judgment, the lender must file a report of sale with the superior court of the county in which the land is located within 30 days after the nonjudicial foreclosure sale. If this deadline is missed, then the lender cannot get a deficiency judgment”;Ga. Code Ann. § 44-14-161[a].

[37] Ga. Code Ann. § 44-14-161[b]). It will also check whether or not the lender followed the correct procedures during the foreclosure proceedings such as notices, advertisements published, fraud or irregularities. If not, the court may order a resale. Thus, the lender takes on risk in attempting to get a deficiency judgment. http://www.nolo.com/legal-encyclopedia/deficiency-judgments-after-foreclosure-georgia.html .

[38] Foreclosures in South Carolina are judicial, which means the lender has to go through state court to obtain a judgment to foreclose.

[39] If the borrower feels that the foreclosure sale price was less than the property’s true value, he or she may ask the court for an order of appraisal within 30 days of the sale.S.C. Code Ann. § 29-3-740 ; S.C. Code Ann. § 29-3-680 ; The borrower, lender, and judge then each designate an appraiser to determine the fair market value of the property as of the date of the sale S.C. Code Ann. § 29-3-710. Once the appraisal has been completed (a majority of the appraisers must agree on the value), the deficiency will be limited to the total outstanding debt minus the fair market value. Here then it is the borrower who must take the initiative and the process involves three valuations.

[40] Texas state law allows the borrower to receive credit for the fair market value of the property. This means the borrower is entitled to an offset in the deficiency amount if the fair market value of the property is greater than the foreclosure sale price…to receive the offset, you must request a review of the fair market value:by responding to the lender’s deficiency judgment lawsuit that follows the nonjudicial foreclosure, or by filing your own lawsuit within 90 days after the date of a judicial foreclosure sale.”

This state is thus a more bank friendly state, as in South Carolina, as it is the borrower who must apply if the bank sells their property for too little. It is however, very clear, that even in these more bank friendly states, should the borrower approach the court, his/her losses will be limited to the fair market value of the property.

[41] This is a loan secured by the home but subsequent to the mortgage. It is thus a junior debt and the mortgage is senior Texas Constitution, Article XVI, § 50[a][6][C]..