What Does It Mean to Waive Deficiency on a Mortgage?

If you are in danger of losing your home to foreclosure, you might consider a short sale to get out of the situation. If that is your plan, make sure that your lender issues a waiver of deficiency on the amount you still owe on the mortgage. Otherwise, you are still not free of some of the burden of the mortgage on a house you cannot afford.

TL;DR (Too Long; Didn't Read)

When your house sells through a short sale, your lender should give you a waiver of deficiency that frees you from the remaining mortgage amount.

Basics of Short Sales

In a short sale, you sell the house for less than you owe on the mortgage. The difference between what you owe on the mortgage and the short sale amount is the deficiency. In most states, your lender can sue you for this amount.

When selling short, make sure to address this issue. You must receive a short sale approval letter from your lender, specifically stating that the deficiency is waived. Don't just take your real estate agent's word for it — check with the lender or your attorney to make sure any money you owe is waived.

Waiver of Deficiency

Other documents, such as lien releases, do not qualify as a waiver of deficiency. If you also have a home-equity loan or any type of second mortgage, you will need letters from those lenders stating the deficiency is waived.

Warning – lenders are not under any obligation to waive a deficiency. However, if your lender fails to approve the short sale price, the deficiency waiver or other terms pertaining to the short sale, either you or the buyer can end the deal if that is a condition of the contract. For that reason, you should hire a real estate attorney to draft the contract and include this provision if the deal falls apart.

Tax Consequences of Mortgage Deficiency

If the mortgage deficiency is waived, that might be the end of the matter. You could still owe taxes on the amount waived. However, the Mortgage Forgiveness Debt Relief Act of 2007 allows you to exclude income from a waiver of deficiency on your primary residence. The Act only applies to forgiven debt in the years 2007 through 2017. Unless Congress makes other provisions, you will have to treat the waived deficiency as taxable ordinary income on your federal tax returns.

Consequences of Lack of Waiver

If the lender doesn't issue a waiver of deficiency, what happens next depends on the state you live in and your circumstances. You might work out a settlement with the lender for a smaller amount than the total owed, or the lender can sue you for the entire amount of the deficiency. Your credit rating has already been hit by the foreclosure and short sale — becoming the defendant in a lawsuit will only make it worse.

You will also have to pay a lawyer to represent you in court, and there is a good chance you'll have to pay the judgment. Fortunately, most lenders will work with you rather than go to court.

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