Kicked While They're Down: Deficiency Judgments and the Great Recession

Emory Law Journal, January 1, 2018 | Go to article overview

Kicked While They're Down: Deficiency Judgments and the Great Recession


INTRODUCTION

Jose Santos Benavides had finally achieved the American dream.1 After emigrating from El Salvador to the United States, he worked for years as a landscaper before he had saved enough money to make a down payment on a four-bedroom home in Rockville, Maryland in 2007.2 Unfortunately, the economy took a downturn over the next year, and Benavides was unable to make his monthly mortgage payments.3 By the end of August 2008, Benavides and his family moved out of their dream home and into a cramped two-bedroom apartment, just days before the bank foreclosed on their home.4 In 2011, Benavides was shocked to learn that he still owed $115,000-for a mortgage on a home his family had not set foot in in over three years.5

In the District of Columbia and forty-two states, if the sale of the foreclosed home does not yield enough money to cover the entire mortgage debt, the lender6 can sue the borrower in a personal action to recover the remaining balance, also called the deficiency.7 If the lender succeeds, it is awarded a deficiency judgment, and can collect from any of the borrower's other assets or income.8 Many borrowers, Benavides included,9 do not understand that they may lose more than their homes if they cannot make their mortgage payments.10 In times of economic crisis, this loss may be insurmountable:11 in 2011, for example, the average deficiency balance remaining after foreclosure in seven states was $100,000.12

Although the market has recovered in part since the worst of the financial crisis,13 deficiency judgments remain a serious problem for many residential borrowers.14 They have a harmful effect on borrowers like Benavides who default on their mortgage payments due to job loss or other financial hardship.15 When the process server gave him notice of the $115,000 deficiency, Benavides was terrified.16 He explained, "I can't pay."17 Shortly thereafter, just five days before Christmas, Benavides filed for bankruptcy.18

Some scholars argue that lenders must be allowed to pursue deficiency judgments to deter borrowers from engaging in what is known as strategic (or "ruthless") default.19 A borrower is said to engage in strategic default when she decides to stop making her mortgage payments despite having the financial resources to do so.20 These scholars argue that without the threat of deficiency judgments, borrowers will simply walk away from their mortgages when the value of the home drops too far below the outstanding debt balance.21 However, the most recent empirical studies addressing this subject find that borrowers are not more likely to engage in strategic default in states that prohibit deficiency judgments.22

This Comment proposes that the lender's remedy after a residential borrower defaults should be limited to foreclosure of the mortgaged real estate.23 A few states already have laws to this effect: what are commonly called anti-deficiency laws, or non-recourse laws.24 Anti-deficiency laws emerged during the Great Depression to help alleviate some of the financial hardship faced by borrowers nationwide.25 The goal was to protect borrowers from losing their homes and being pushed toward filing for bankruptcy by the imposition of a deficiency judgment.26 This rationale remains sound. Even when the economy is relatively stable, deficiency judgments work an unnecessary hardship on residential borrowers. Lenders are in a better position to reduce their exposure to losses from default prior to originating residential mortgage loans.27 Lenders are also better able to absorb post-default losses due to declining property values.28

This Comment proceeds in three parts. Part I describes the basic attributes of mortgage loans and state foreclosure procedures that make deficiency judgments possible. Part I also discusses the origins of anti-deficiency laws during the Great Depression and explains the rationale behind the laws at the time. Finally, Part I concludes by briefly explaining why deficiency judgments were particularly staggering in the wake of the 2008 financial crisis. …

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