Joseph Reilly lost his vacation home here last year when he was out of work and stopped paying his mortgage. The bank took the house and sold it. Mr. Reilly thought that was the end of it.
In June, he learned otherwise. A phone call informed him of a court judgment against him for $192,576.71.
It turned out that at a foreclosure sale, his former house fetched less than a quarter of what Mr. Reilly owed on it. His bank sued him for the rest.
The result was a foreclosure hangover that homeowners rarely anticipate but increasingly face: a "deficiency judgment."
This is why it's so important to see a bankruptcy attorney early in the process of letting a home go back to the bank. You need to know your rights, the foreclosure process, the bank's rights, how bankruptcy might be a tool and develop a strategy.
Forty-one states and the District of Columbia permit lenders to sue borrowers for mortgage debt still left after a foreclosure sale. The economics of today's battered housing market mean that lenders are doing so more and more.
Foreclosed homes seldom fetch enough to cover the outstanding loan amount, both because buyers financed so much of the purchase price—up to 100% of it during the housing boom—and because today's foreclosures take place following a four-year decline in values.
"Now there are foreclosures that leave banks holding the bag on more than $100,000 in debt," says Michael Cramer, president and chief executive of Dyck O'Neal Inc., an Arlington, Texas, firm that invests in debt. "Before, it didn't make sense [for banks] to expend the resources to go after borrowers; now it doesn't make sense not to."
Indeed, $100,000 was roughly the average amount by which foreclosure sales fell short of loan balances in hundreds of foreclosures in seven states reviewed by The Wall Street Journal. And 64% of the 4.5 million foreclosures since the start of 2007 have taken place in states that allow deficiency judgments.
Lenders still sue for loan shortfalls in only a small minority of cases where they legally could. Public relations is a limiting factor, some debt-buyers believe. Banks are reluctant to discuss their strategies, but some lenders say they are more likely to seek a deficiency judgment if they perceive the borrower to be a "strategic defaulter" who chose to stop paying because the property lost so much value.
In Lee County, Fla., where Mr. Reilly's vacation home was, court records show that 172 deficiency judgments were entered in the first seven months of 2011. That was up 34% from a year earlier. The increase was especially striking because total foreclosures were down sharply in the county, as banks continued to wrestle with paperwork problems that slowed the process.
Banks are probably going after deficiencies in this county because the perception is a vacation home owner has other assets and means to recoup the deficiency from because they in general are more affluent, which may or may not be the case by the time foreclosure has occurred.
One Florida lawyer who defends troubled homeowners, Matt Englett of Orlando, says his clients have faced 20 deficiency-judgment suits this year, up from seven during all of last year.
Until recently, "there was a false sense of calm" among borrowers who went through foreclosure, Mr. Englett says. "That's changing," he adds, as borrowers learn they may be financially on the hook even after the house is gone.
In Mr. Reilly's case, "there's not a snowball's chance in hell that we can pay" the deficiency judgment, says the 39-year-old man, who remains unemployed. He says he is going to speak to a lawyer about declaring bankruptcy next week, in an effort to escape the debt. The lender that obtained the judgment against him, Great Western Bank Corp. of Sioux Falls, S.D., declined to comment.
Some close observers of the housing scene are convinced this is just the beginning of a surge in deficiency judgments. Sharon Bock, clerk and comptroller of Palm Beach County, Fla., expects "a massive wave of these cases as banks start selling the judgments to debt collectors."
Bankruptcy is just a tool, and if banks pursue this line of litigation more universally for deficiencies, personal bankruptcies could sky rocket!
In a paradox of the battered housing industry, trying to squeeze more money out of distressed borrowers contrasts with other initiatives that aim instead to help struggling homeowners, including by reducing what they owe.
The increase in deficiency judgments has sparked a growing secondary market. Sophisticated investors are "ravenous for this debt and ramping up their purchases," says Jeffrey Shachat, a managing director at Arca Capital Partners LLC, a Palo Alto, Calif., firm that finances distressed-debt deals. He says deficiency judgments will eventually be bundled into packages that resemble mortgage-backed securities.
Because most targets have scant savings, the judgments sell for only about two cents on the dollar, versus seven cents for credit-card debt, according to debt-industry brokers.
Silverleaf Advisors LLC, a Miami private-equity firm, is one investor in battered mortgage debt. Instead of buying ready-made deficiency judgments, it buys banks' soured mortgages and goes to court itself to get judgments for debt that remains after foreclosure sales.
Silverleaf says its collection efforts are limited. "We are waiting for the economy to somewhat heal so that it's a better time to go after people," says Douglas Hannah, managing director of Silverleaf.
Waiting for the economy to somewhat heal so that it's a better time to go after people?
Good luck with that ignorant thought process. The improvement needed to provide people the means to repay a deficiency of size is just too big and has to last too long. We would need another round of bubble economics, and we are in deflation. I say good luck with that line of thinking!
Investors know that most states allow up to 20 years to try to collect the debts, ample time for the borrowers to get back on their feet. Meanwhile, the debts grow at about an 8% interest rate, depending on the state.
If the industry thinks they are going to be able to recoup this money in 5, 10 or 20 years, they are smoking crack for the most part.
The deficiency now plus 8% interest creates too much of an incentive for people in the future to give up and file Bankruptcy because you essentially create a form of financial slavery.
What they might get is a percentage of people willing to negotiate a settlement of cents on the dollar to keep or maintain their personal credit.
Mr. Hannah expects the market to expand as banks "aggressively unload" their distressed mortgages in the next year, driving up the number of deficiency judgments being sought.
I would tend to agree, as banks need to show a more progressive plan to cleansing their balance sheets in the next 1-3 years, and they have lots of work to do on this front. That could easily increase the number of deficiency judgements in the future. The question is how, when, or will they go after these people?
They are pretty easy to get. "If the house sold for less than you owe, the lender wins, plain and simple," says Roy Foxall, a real-estate lawyer in Fort Myers on Florida's west coast.
Mr. Foxall says five deficiency suits were filed against his clients this year, and he couldn't poke any holes in any of them. Lenders typically have five years following a foreclosure sale to sue for remaining mortgage debt.
Mr. Englett, the Orlando lawyer who has handled 27 such suits for homeowners in the past 21 months, says he didn't get the bank to waive the deficiency in any of the cases, but did reach six settlements in which the plaintiff accepted less.
Florida is among the biggest deficiency-judgment states. Since the start of 2007, it has had more foreclosures than any other state that allows deficiency judgments—more than 9% of the U.S. total, according to research firm Lender Processing Services Inc.
A loan-deficiency suit can yank borrowers back to a nightmare they thought was over.
Ray Falero, a truck driver whose Orlando home was foreclosed on and sold in August 2010, says he thought he was hallucinating when, months later, he opened the door and saw a sheriff's deputy. The visitor handed him a notice saying he was being sued for $78,500 by the lender on the home purchase, EverBank Financial Corp., of Jacksonville, Fla.
"I thought I was done with this whole mess," he says.
Mr. Falero, 37, says he was about nine months behind on his loan when the bank foreclosed. Before it did, he bought another home in Minneola, Fla., where he now lives and where he says he is up to date on mortgage payments. Like Mr. Reilly, Mr. Falero says he didn't swell the foreclosed-on loan through refinancing or home-equity borrowing.
EverBank won a deficiency judgment on Mr. Falero's Orlando loan. Mr. Falero and his lawyer are fighting to reduce the amount owed. EverBank declined to comment on his case.
The process should end up in a negotiated settlement for a lowered amount that's affordable or it will push people into bankruptcy. Again, this is why one needs to see an attorney as early as possible, long before actual foreclosure if possible.
Credit unions and smaller banks are the most aggressive pursuers of deficiency judgments, a review of court records in several states shows.
At Suncoast Schools Federal Credit Union in Tampa, Jim Simon, manager of loss and risk mitigation, says the institution has a responsibility to its members, and that means trying to recoup losses by going after loan deficiencies. He calls such legal action the credit union's "last arrow in the quiver."
The biggest banks appear to have stayed largely on the sidelines as they deal with the foreclosure-paperwork mess. One big bank, J.P. Morgan Chase & Co., "may obtain a deficiency" judgment in foreclosure cases but will "often waive" the leftover debt when a homeowner agrees to a so-called short sale of a house for less than is owed on it, a bank spokesman says.
Among the hardest-hit spots in Florida is Lehigh Acres, a 95-square-mile unincorporated sprawl of narrow, cracked-pavement streets about 15 miles inland from Fort Myers.
Lehigh Acres was carved out of scrub land and cattle farms in the 1950s by a Chicago businessman, Lee Ratner, who had made a fortune on d-CON rat poison, says Gary Mormino, a history professor at the University of South Florida in St. Petersburg. Before he died, Mr. Ratner sold prefabricated houses to families hungry for a slice of paradise.
Decades later, Lehigh Acres (population 68,265) attracted people eager to cash in on the housing boom, even though it is distant from the sugary white beaches on the Gulf of Mexico. Speculative investors bought more than half of homes sold in Lehigh Acres in 2005 and 2006, Bob Peterson, a real-estate agent, estimates.
Many of those stucco homes now stand empty, priced at about a third of the value they had at the peak of the housing boom, which was often around $300,000.
In the first seven months of this year, courts entered 42 deficiency judgments in Lehigh Acres, for a total of $7 million, up from 26 judgments for $4.6 million in the same period of 2010, according to a Wall Street Journal analysis of state-court records.
Fifth Third Bancorp, of Cincinnati, filed for the largest share of deficiency judgments in Lehigh Acres last year. The bank declined to comment.
"It's eerily quiet around here," says Jon Divencenzo, who bought a house in Lehigh Acres at a May foreclosure sale for $50,000. Some nights, he says, the only sounds are rustling pine trees and the idling car engines of former homeowners circling the block to glimpse what they lost.
The hard-hit area reveals a sharp contrast in homeowners' attitudes toward deficiency judgments.
Julia Ingham invested in four Lehigh Acres properties in June 2005, hoping to "drum up some real money for retirement."
All have since been foreclosed on by lenders, says the 62-year-old retired programmer for International Business Machines Corp.
A credit union, after selling one of the foreclosed houses for less than the debt on it, obtained a deficiency judgment against Ms. Ingham for $181,059.54. She worries she could face such judgments on the other properties, too.
Ms. Ingham says when she bought them, she misunderstood how much her investments put her on the hook for. Her builder, she says, promised she could invest $10,000 in four properties and then flip them for a profit. Ms. Ingham says deficiency judgments punish borrowers who were taken advantage of by lenders and builders.
Catherine Ortega, who owns a Lehigh Acres home around the corner from one of Ms. Ingham's foreclosed homes, says banks should leave people like her former neighbor alone. "Those people have suffered enough," she says.
In July 2005, Mr. Reilly took out a $223,000 mortgage to build a vacation home here, about 160 miles from his primary home in Odessa, Fla. He was laid off just as construction was being completed.
Mr. Reilly says he is current on the loan on his primary residence but couldn't afford the vacation home's $1,200-a-month loan payment. Great Western Bank, which is owned by National Australia Bank Ltd., foreclosed on his house in Lehigh Acres in July 2010.
Mr. Reilly, who was a mortgage broker before his layoff, says he knew that deficiency judgments were possible after a foreclosure but didn't expect to face one because he doesn't have any financial assets, and you can't get "blood from a stone."
Alfredo Callado, who lives next door to Mr. Reilly's former house, is unsympathetic. Like Ms. Ortega, Mr. Callado is troubled by the crime that a neighborhood full of empty houses attracts. He started watching over Mr. Reilly's former house to ward off thieves who steal air conditioners from vacant properties.
Mr. Callado, sitting on a lawn chair in his driveway, says lenders should use deficiency suits to punish defaulting homeowners for the damage they do to neighborhoods, including driving down property values.
"You have to make them pay for what they do to those of us left behind," he says.
It's imperative that anyone buying a house or thinking about walking away from a mortgage understands if they are in a deficiency state. Again, see an attorney!
If you are in a deficiency state, then the last thing you want to do is buy a home that is still in an over valued market because eventually it will go down in value and create a potential deficiency. You also want to make sure that your debt is well within your means and that you have cash reserves to withstand financial issues.
If you already own a home and thinking about letting a home go back to the bank, then you need to see an attorney. You need to understand what kind of state you live in, what your rights are, and how foreclosure works, and whether bankruptcy someday might be a tool. All of that can help you form a plan.
The Bad News
If the deficiency issue explodes back onto the public, the impact economically could be quite negative because there are really two solutions.
Either people pay up in what will be some kind of payment plan over years or lowered settlement, which will reduce consumer spending for those who can actually afford to do this.
Or, a wave of personal bankruptcies will stem from this. That will allow people to wipe out not only the deficiencies but other unsecured credit card debts creating more losses for banks. That will also block these people from borrowing, which will remove them as potential home buyers.
The deficiency issue is an interesting after thought to the real estate nightmare. It might also create a great deal of uncertainty for potential home buyers in the future.
It has plenty of negative ramifications for the economy and real estate market. It's a natural part of the legal process that surely isn't going to go away on it's own.
The winners are the attorneys who should see an increase in business, and the companies who buy deficiencies for pennies on the dollar, which isn't much to write home about!
Hope all is well.
J.D. Rosendahl, Rosey