Tennessee court limits deficiency judgments

The law in 40 states allows lenders to obtain a deficiency judgment against the homeowner who has lost his or her property in foreclosure. This type of judgment is sought when the home sells for less than the remaining balance of the mortgage. It is intended to compensate the lender for the shortfall. Although this practice is legal in Tennessee, a recent bankruptcy court ruling has placed limits on its use.

When a person's house has been foreclosed upon, many lenders send the homeowner IRS Form 1099-C. This form is used to calculate the tax owed on forgiven debt (i.e. the deficiency). However, sometimes lenders would also sue to collect the deficiency in addition to sending the form. This issue was the subject of the court's decision.

In the decision, a Tennessee bankruptcy court ruled that while the form itself does not cancel the deficiency debt, it does serve as evidence that the lender intended to abandon efforts to collect the deficiency. Since the homeowner owes taxes on the forgiven debt, the court ruled that it would be unjust to also permit lenders to collect the deficiency if they had evidenced their intent to forgive the debt by sending out the form.

This ruling gives Tennessee homeowners facing foreclosure additional protection. The decision does not bar lenders from pursuing deficiency judgments, but prohibits lenders from simultaneously forgiving the deficiency and then suing to collect it.

Bankruptcy can help

Unfortunately, the court's ruling only provides relief to those who have already been through the foreclosure process. If you are struggling with your debts and cannot pay your mortgage, it is best to take action as early in the foreclosure process as possible before your situation worsens.

Chapter 13 bankruptcy can help stop foreclosure proceedings and allow you to stay in your home. This type of bankruptcy works by consolidating your debts into a repayment plan. You repay all or a portion of your debts over a three to five year period. While you are making payments, lenders may not foreclose on your house.

Under the plan, your secured debt (e.g. mortgage or car loan) is brought up to date over the repayment period. However, unsecured debt such as credit cards or medical bills is paid last (or not at all) under the bankruptcy laws. As a result, most of this type of debt is discharged at the end of the bankruptcy process.

Once the Chapter 13 process is over, you find yourself current on your secured debt and free of most of your unsecured debt, giving you a fresh financial start. As bankruptcy may or may not be right for your situation, it is important to consult with an experienced bankruptcy attorney as soon as you experience financial problems. An attorney can advise you of the debt relief options available to you and recommend one that would be best for your situation.