As more homeowners fall behind on their house payments or find themselves "underwater" on their mortgages, many are choosing to simply give up the home through foreclosure or a short sale. Unfortunately, that doesn't always free them from their financial burden.

More and more, homeowners who have lost their homes through foreclosure or given them up through a short sale are shocked to discover their lenders are still coming after them for the unpaid balance on the mortgage. Because the proceeds from a foreclosure or short sale almost never covers the full debt of the mortgage, the former homeowners can still be held liable for the remaining balance in many states.

"Voluntary foreclosures," short sales may be affected

 

This is a major concern for underwater homeowners who may be contemplating a "strategic default" or "voluntary foreclosure;" that is, to stop making payments and simply give up a home where the balance owed exceeds what the property is worth due to declining housing values. Simply walking away from the mortgage may not free them of their obligations as readily as they had hoped. Similarly, homeowners pursuing a short sale may find that the fine print did not fully absolve them of their debt, meaning collection agencies may still come after them.

The technical term is called a "deficiency judgment" and, depending on the state, it can allow a lender to come after defaulting borrower's savings, personal property, wages or place liens on property purchased years after the default.

Lenders trying harder to recover losses

 

In the past, this rarely happened, because it's expensive for lenders to seek to collect the remaining balance and people who've lost their home typically don't have much money anyway. However, it's becoming more common as lenders face increasing losses from bad mortgages and try to recover whatever they can.

This tends to be more of an issue with holders of second liens, such as home equity loans or lines of credit, who typically get little or nothing out of a foreclosure sale these days, given that housing values have fallen so far. The lender may opt to sell the debt to a collection agency in order to recover some small portion of the debt, and then the collection agency goes all-out to collect what it can.

Mortgage debt is personal obligation

 

Most homeowners assume that if they default on the mortgage, they simply forfeit the property and that's the end of it. However, what they're actually doing is signing a promissory note, a personal commitment to pay the loan, which is secured by the property they're buying. The lender can take the property if they don't pay, but that doesn't get them legally off the hook if it doesn't cover everything they owe.

Laws vary from state to state and many prohibit a lender from collecting an unpaid balance on a mortgage where the home has gone into foreclosure. However, in some cases this only applies to the primary mortgage or a loan actually used to purchase the home; lenders may still be able to seek an unpaid balance on a refinanced mortgage, second mortgage or home equity line of credit.

Get it in writing

 

The key thing to do, if you're considering a short sale, is to ensure that the short sale agreement specifically frees you from any future obligations for the mortgage. Because any second lien holders have to sign off on the agreement as well, you don't have to worry about them as long as this provision is included. It's a good idea to hire an attorney to review the agreement before you sign it just to make sure you're off the hook.

If you go into foreclosure, either voluntarily or not, the situation is a bit more complicated. You may be able to negotiate an agreement with your lender in which you agree to give up the property sooner rather than later, and in good condition, in return for being freed from further obligations. You might even be able to get them to agree to share a small slice of the proceeds with a second lien holder in return for being freed from that obligation as well.

If you're doing a "voluntary" foreclosure though, it's more likely that a lender may seek to go after assets you were trying to protect by giving up the mortgage. Before going this route, it's best to talk with a good real estate attorney. Better yet, do what you can to avoid foreclosure by seeking a loan modification, refinance or other remedy.

Published on January 29, 2010