A deficiency judgment is something that looms over the head of everyone who has to take a loss on their house, whether by foreclosure or by short sale. This isn’t the law in every state, but in many areas the mortgage lender is allowed to sue for the unpaid debt after the sale of the home – and when they can, they usually will.

You also probably know that a deficiency judgment is something that we all want to avoid, but why? What happens after the judge lays down the gavel?

Deficiency judgments are often only avoided through negotiation with the bank before the foreclosure. In the process of getting a short sale approved, the homeowner or his agent can sometimes ask the bank waive their right to further collection efforts if the house is sold. Considering the cost of keeping an REO property and the fact that the homeowner is usually broke at that point, the bank will sometimes agree to this.

When that isn’t possible, depending on state law, the homeowner may have a deficiency judgment on their hands, whether the short sale was approved or the foreclosure went through. At that point, the debt only goes away through payoff or bankruptcy.

Let’s say that the foreclosure went through. In most states, a judge will look at both the highest bid at the foreclosure auction and the appraised value of the house. The greater dollar amount of the two is subtracted from the balance due on the mortgage, and that is the amount of the deficiency judgment against the borrower. In the case of a short sale, the judge subtracts the sale proceeds from the balance due.

So, the former homeowner now has a court order which says he has to pay the rest of that mortgage debt to the bank. If there were two or more mortgages or liens, that homeowner may even have two or more deficiency judgments against him.

The very first thing that a deficiency judgment does is to earn interest. The bank may add its REO expenses, which gives them even more money on which to charge interest. Florida allows banks to charge an interest rate of 11 percent per year for deficiency judgments. What does your state allow?

Next, the lender usually sells these types of debt to collection companies for 5 to 10 percent of the amount due. Since they know their chances of collecting the debt from a financially drained homeowner are slim to none, lenders would rather get the debt off their books and get what they can out of it.

Payment or no payment, the former homeowner now also has a huge ding on their credit report, as if having a foreclosure on record wasn’t bad enough. That judgment will stay on a credit report for at least seven to ten years, depending on certain circumstances, and it will send a FICO score down. That lower FICO score means that the former homeowner could be turned down for loans, jobs, or even housing because of it.

More properties go into foreclosure every day, and with the increase in foreclosures comes the increase in deficiency judgments. With all the changes going on in the mortgage industry, maybe we will soon see a change in the way that deficiency judgments are handled. Then again, maybe we won’t.

In the meantime, if you are about to lose your home, your best bet is to try talking with the lender. You or your agent may be able to help their loss mitigation department see how cost-effective it is for them to tell the credit bureaus that your mortgage is “paid in full as agreed.” If you don’t take the time to negotiate now, you could be paying for it later.

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