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In the current, distressed state of the American housing climate, the rate of bankruptcy filings is approaching an all-time high. It seems that everyone knows somebody losing their house. It’s a terrible and sometimes scary situation, true, but for many the home loss associated with a foreclosure is something of an end to a terrible chapter in their own life story. The massive financial headache is over, and life can at least go back to normal… right? Not so fast. You might THINK that you are off the hook from your sinking mortgage when you hand over the keys to the property, but that is not always the case. Some homeowners may still be on the hook for their obligations, depending on the difference between what they still owe on the mortgage and what price the property is able to fetch at public auction. Years could go by while you think that you are out of the woods, while meanwhile your former lender is preparing a dreaded “deficiency judgment” against you. Worst of all, this can happen to those who thought that they had made amends with their bank through coming to approved short sale agreements.

I read a great article about this recently on CNN Money. It told the story of Vanessa Corey, a former homeowner in Fredericksburg, Virginia who had to claim bankruptcy after being sued by her former lender for the sixty-five thousand dollar difference between her mortgage amount and the sum for which Corey was able to sell the home in short sale. Corey had built her home with her now ex-husband in 2004, only to see tremendous setbacks in the form of a divorce and the housing bust make it impossible for her to keep up with payments. Realizing her predicament, Corey worked with the bank and negotiated a short sale. She thought that was the end of her housing problems, but she was wrong. She’s a good example of the troubling fact that homeowners can do everything that they reasonably consider to be the right thing – negotiating with their lender and keeping them abreast of what’s going on rather than simply ignoring late bills – and still manage to end up in a lot of trouble. Bankruptcy ended up being the only option for Corey, who simply could not come up with the phenomenal chunk of change being requested by the bank for her deficiency. Her beautiful family home ended up a sinking ship, and her dream turned within a few short years into a terrible nightmare. And it’s happening much more commonly than you might think.

Corey is far from the only American homeowners to ever get ensnared in this horrible net. Not are those getting burned solely those who took out “liar loans” during the free-and-easy lending days of the housing bubble or those who took a bite out of bigger home loans than they could afford in the name of living above their means. The very real fact that we are entering the third consecutive year of plummeting home values has made it so that normal people who have owned their homes for years and paid in full and on time are still upside down and in the same predicament. If they become unemployed, like so many U.S. consumers, or end up transferred to a new city at the job that they do have, selling their home for the value at which it is mortgaged is very likely no longer a possibility. These unfortunate souls are all but forced to short sell their properties, or to foreclose with no options left. And then, just after dealing with the terribleness of that crisis, they are finding themselves on the receiving end of deficiency judgments. Depending on when the homeowner bought the home and what the value was at that time, it’s not at all uncommon anymore for people to find themselves with large deficiencies with houses not worth the balances owed. In cases where the balance runs into tens of thousands of dollars, banks refuse to let the loss go and resort to suing the former homeowners.

Are you at risk of being pursued for a deficiency judgment? It all depends on a number of factors. What state the borrow resides in is a major one, as is the presence of a second mortgage or additional liens against the property if they happen to exist. It’s crucial to educate yourself as to your own options if you are facing a foreclosure. In any case, you shouldn’t simply assume that you are safe from a deficiency judgment just because the ink on your foreclosure is dry. Once a judgment is obtained, your former lender has tremendous power over you – they may cash for your financial records to determine your ability to pay, have your wages garnished and, in severe cases when a defendant does not respond, have you put in jail. In cases of foreclosure, lenders may pursue deficiencies in thirty U.S. states. There are states that do not allow deficiency judgments as “non-recourse” territories, but you may still find yourself in trouble if the original loan was refinanced at any time during its life.

Deficiency judgments taking place after a short sale can happen in many more states, however. The bank has the final say on extinguishing the debt in these situations. It’s a little-known fact that many lenders are willing to do so, if a borrower only asks for it. If you are in the process of negotiating a short sale, it is crucially important to ask your attorney to request that the bank release you from future obligations taking place as a result of what you owe. You shouldn’t have a false sense of security, when the truth is that in many situations banks sell these deficiencies at discount to collection agencies and other third parties, at which point you might find yourself on the hook for a legal obligation to someone you have never dealt with. After all, nobody would purchase these notes if they did not have the intention of collecting upon them! Lenders might purposefully wait until they think a homeowner has had ample time to financially recover before swooping in to collect. And the statute of limitations is insanely long. In Florida, for instance, banks may wait as long as five years after a foreclosure or short sale judgment to file suit. Once a judge has ruled in the bank’s favor, the lender has twenty years to collect on their debt owed, with interest!

Nor is it always the case that there needs to be a large debt to collect for it to be “worth it” for lenders to sue you for it. That’s a misconception. Another former homeowner interviewed as part of the CNN Money feature was on the hook to the bank for less than twenty thousand dollars! This gentleman thought that he has released the title for the second lien on his home. He had, but that wasn’t the end of the story. Releasing the title on a home does not necessarily end the debt. That it does is another misconception. A mortgage actually has two parts, a fact that is very complicated for most homeowners to understand. There is a pledge of collateral (the home itself), and a promise to pay off the loan as agreed. Lenders may release the title as part of the lien transfer involved in a short sale without necessarily releasing former homeowners from their contractual obligation to pay as spelled out in the promissory note. Therefore, after the sale, a secured debt converts into an unsecured one. At this point, banks have the option to pursue you in many different ways. Your collateral – the house – was gone with the foreclosure or short sale, but you are still very much on the hook.

Lenders are also notoriously inconsistent in their treatment of deficiencies. Some simply will not bother asking for payment, even when a borrower is ready and willing to pay the difference in what they owe. Another lender mentioned by an attorney quoted in the story – although not named – makes it a rule to always pursue deficiencies. Some banks will make the final decision on whether or not to sue based on the question of whether a client has any assets worth collecting. Pulling a client credit report can answer that question pretty quickly. Banks can tell if you have utilized a strategic default to protect other assets by cutting loose a sinking mortgage. If you are behind on all sorts of other obligations, however, you will generally be all right because your lender will be able to tell that you have nothing to give them. Borrowers should generally seek legal advice before they make any important real estate decisions, in the hope that they will end up with someone who can negotiate away a legal deficiency before it causes problems later in life. You never can be too careful when it comes to banks and the ins and outs of the law… odds are great that they know it better than you do, and will use that knowledge against you!