What Is a Deficiency Balance?
A deficiency balance is the net difference between the amount you owe on a secured loanand the amount the creditor receives after selling the collateral that secures the loan.
Typical examples of when a deficiency balance is when a lender repossesses a car or a home because the you've failed to make payments. The lender will attempt to recover the remaining loan balance by selling the property. However, if the sale does not result in the lender recovering the full loan balance, the resulting shortfall is the deficiency balance. The lender may also add administrative fees and costs associated with selling the collateral to the total deficiency balance. Learn more about deficiency balances.
Key Takeaways
- A deficiency balance is the amount owed to a creditor after collateral and applied to the loan balance.
- A creditor can seize your assets for sale when you fail to make payments on a secured loan backed by the asset.
- The creditor may absorb the deficiency balance, pass the deficiency balance back to the borrower, or negotiate a settlement.
- A loan closed with a deficiency balance can appear on your credit report as: a charge-off, settlement, or deed in lieu of foreclosure.
How a Deficiency Balance Works
A deficiency balance usually occurs in situations where a borrower can no longer afford to make payments. The borrowereither negotiatesa lower settlement with the lender on what is owed or defaultson the loan. This is sometimes also referred to as being "upside-down" or "underwater" on a loan.
The borrower's remaining responsible balance may be increased by the creditor to cover any additional legal costs that they may have incurred during the process of regaining possession of the collateral. The deficiency balance can either be absorbed by the lender or the lender can pass responsibility for the debt back to the borrower.
With auto loans, this expense is usually passed back to the borrower and is part of the repossession. Withmortgages, the party responsible for the balance is usually negotiated between the mortgage lender and the homeowner. Sometimes it can be negotiated by a third-party agent acting on the homeowner’s behalf. These processes are known as foreclosures or short sales.
How a Deficiency Balance Affects Your Credit
When the lender enforces your responsibility for the remaining debt, the account will continue to report as open on your credit report until it is paid in full. Or, the servicer could also waive the remaining balance to discharge the debt, and then your credit reportwill reflectthe manner in which the loan was paid off.
Generally, when a loan is closed satisfactorily, it will show as paid as agreed. When it is closed with a deficiency balance, it can be reported a few different ways but is most commonly reported as a charge-off, settlement, or deed in lieu of foreclosure.
Consumers should be aware that the Internal Revenue Service (IRS) may count waived deficiencies as earned income. Consider consulting a certified tax specialist about your tax responsibility regarding waived deficiencies.
Examples of a Deficiency Balance
Consider a deficiency balance in an example of a short sale. Say you own a home with a remaining mortgage balance of $250,000. You can no longer afford to make monthly payments. The value of your home is only $200,000. If the lender seizes and sells your home for the market value, there would be a deficiency balance of $50,000, along with costs orfees associated with executing the sale of the home.
Say you have negotiated a short sale with your loan servicer, who has agreed to accept less than what is owed on the property to satisfy the mortgage. After the closing, the servicer writes off the remaining balance of $50,000 and closes the mortgage without further responsibility to you.
An auto lender may take a different approach. Imagine the same situation with a car loan that you can no longer afford. The auto lender repossesses the car. You owe $10,000, but the lender is only able to sell the car for $8,500. The deficiency balance is $1,500 and the auto lender passes this cost back to you. The auto lender contacts an attorney and you go to court to levy a deficiency judgment against you for the $1,500 balance remaining and the additional $500 in fees that you incurred as part of the repossession.
Frequently Asked Questions (FAQs)
What Happens If You Don't Pay a Deficiency Balance?
When you have a deficiency balance, you are responsible for paying it. If you don't pay it, the lender could sue to have your wages garnished or send the debt to collectors, who can also take steps toward garnishing your wages.
How Can You Pay a Deficiency Balance?
You can pay a deficiency balance, or money owed to the lender, in several ways. You can make a lump-sum payment to settle the debt. If you don't have funds, you may be able to get on a payment plan or negotiate a settlement for less than what you owe.
What Is a Deficiency Balance Letter?
When a lender repossesses and sells your asset to pay off a loan, you will receive a letter notifying you if you have any remaining balance. This notice is sometimes referred to as the deficiency balance letter.
The Bottom Line
A deficiency balance is the amount of money leftover after your assets have been seized by a lender and the value applied to a loan. It is the amount you are still responsible for paying the lender if the money from the seized assets does not cover the amount you owe. Addressing a deficiency after a repossession is important to protecting your finances from further damage.
