Short Sales: What Happens To The Unpaid Loan Balance After A Short Sale?

Most people who are thinking about doing a short sale want to know what happens to the unpaid loan balance after the sale.  Homeowners often ask me if they are going to be responsible for the difference between the reduced amount their bank receives at closing and the amount they actually owed for their mortgage.  After a short sale, your lender will either:

Issue you a 1099C*

2.      Pursue a deficiency judgment against you in court*

3.      Do nothing

*A bank cannot issue a 1099C and pursue a deficiency judgment against you at the same time—they must choose one or the other 

The unpaid loan balance after a short sale will most likely result in a 1099C.  By issuing you a 1099, your bank gets an immediate tax benefit from a short sale.  The 1099 your bank sends you after a short sale can register as income, which may result in you owing taxes.  However, there are many exceptions that exclude canceled debt for tax purposes, so a 1099 may not adversely affect you.  You should speak with a competent accountant for advice on the financial consequences of a 1099.

After a short sale, your lender may pursue a deficiency judgment against you.  A deficiency judgment only occurs if a bank sues a borrower for the unpaid loan balance after a short sale and wins the court case.  If the bank wins, the borrower is legally required to pay the amount of the judgment (Note: retirement accounts are generally protected from creditors even if a bank wins a deficiency judgment in court). 

Although it is a possibility, mortgage lenders rarely pursue deficiency judgments against borrowers after a short sale because the process is expensive and time consuming.  Your lender would have to take you to court, hire local attorneys to file the lawsuit, get a judgment from the court and then have it enforced in the county where you live (assuming they can find you).  If the lawsuit paperwork is filed incorrectly, the deficiency judgment can actually be overturned.  Moreover from the bank’s perspective, if you had the money to pay a deficiency judgment, you probably wouldn't have missed your mortgage payments in the first place.

Before a short sale is completed, banks sometimes ask homeowners either to make a one time payment at the closing table or accept an unsecured promissory note for some or all of the unpaid debt being forgiven.  Like collection calls, this is another attempt by the bank to reduce its losses.  Sometimes bank representatives use scare tactics over the phone to threaten or intimidate borrowers.  Aggressive collection agents have been known to lie in a desperate attempt to get more money from borrowers.  It is always your choice whether to accept or reject a promissory note request from a lender.  

So, how will you know what your bank will do with your unpaid loan balance after a short sale?  Unfortunately, there is no way to know for sure.  In most cases, it pays to be proactive and tell your lender exactly what you want them to do, which ideally is to accept the short sale as payment in full for your mortgage and give you a waiver of deficiency.   You can call your lender and ask them to do this or simply write the request directly into the sales contract you sign with the buyer purchasing your property.  There’s no guarantee, but your effort can only help your chances.