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For example: I might owe $250,000 but I can’t get an offer for more than $220,000.
The lender has options for handling the balance owed, or the deficiency.
The lender may agree to terms under which they write off the loan, and the homeowner will not be asked to repay any of the deficiency. However, when the bank declares a loss to the IRS, the IRS will send a 1099 to the homeowner to pay tax on the deficient amount. (The seller may not be required to pay taxes if the property was the homeowner’s primary residence qualifying them for relief under that 2007 Mortgage Forgiveness Debt Relief Act, or if the property is not the primary residence and the homeowner is insolvent at the time of the short sale)
The bank may attempt to collect all or part of the deficiency from the homeowner in one or more ways.
Unsecured Note – the lender may require that the homeowner sign a promissory note for all or part of the deficiency under negotiated terms.
Cash Contribution – the lender may require a cash contribution from the homeowner at closing for part of the deficiency.
Deficiency Judgment – The lender may preserve the right to pursue a deficiency judgment at a later date. The lender could choose to file suit against the seller for a judgment in their favor of all or part of the deficiency, and could file liens or seek other means to recover all or part of the deficiency.