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If you've had a repossession or a foreclosure, or you voluntarily returned property to a lender because you could no longer afford the payments, your obligation might not be over just yet. You could owe a "deficiency balance" if the property value doesn't cover the cost of your outstanding debt obligation.
When a deficiency balance is owed, the lender can take certain steps (including legal action) to claim the remaining debt. You may be asked to pay your deficiency balance in a lump sum, but if you don't have the money, you can try working with the lender and come up with an affordable repayment option.
What Is a Deficiency Balance?
When a lender seizes property from you, whether it's your home, your vehicle or other property, they will typically sell it to recover the remaining balance on your loan. But the sale may not cover the full amount you owe, including any new fees you may have incurred.
When the sale of your property falls short of covering your full balance, the remaining debt becomes a deficiency balance, which you could be required to pay.
Some of the most common events that result in a deficiency balance include foreclosure, deed-in-lieu of foreclosure and a short sale. When it comes to your car, you could have a deficiency balance after having your vehicle repossessed or after you voluntarily surrender your vehicle.
What Options Do You Have When You Owe a Deficiency Balance?
Even if you voluntarily turn over your property, you may have to pay a deficiency balance. If you refuse to pay, the debt will most likely be sold to collections. But either the lender or the collector can choose to file a lawsuit against you, which could result in a wage garnishment, a levy against your bank account or a lien against your other property.
The safest course of action is to pay the full remaining balance owed. If you can't afford the amount due, make sure to communicate that to the lender immediately. You may be able to negotiate a settlement or an affordable payment plan to avoid being sued.
There are a few circumstances in which you may not have to pay a deficiency balance. In some states, the law doesn't allow lenders to collect the deficiency balance if you voluntarily surrender your home. You may even be able to get your lender to waive the balance as a part of your agreement to let go of your house.
Some people who are sued for a deficiency balance may have a legal defense against paying. If you live solely off of federal benefits or simply have no way to afford repayment, a wage garnishment may not be allowed. You can also defend against judgment if you can prove that the lender didn't make an effort to sell your property for fair market value.
How Does a Deficiency Balance Affect Your Credit Score?
Owing a deficiency balance doesn't directly affect your scores, but the circumstances leading up to the deficiency may have a severe negative impact. Here are some credit activities that hurt your scores:
- Delinquent loan payments: Your debt payment history is the biggest factor in calculating your credit scores, so when you miss an auto loan payment or a mortgage payment, your scores take a big hit.
- Loan default: Your credit scores take an additional hit when your loan enters default, which can happen once you're anywhere from 30 to 90 days late, or later.
- Repossession: Vehicle repossession has a serious negative impact on your scores, and stays on your credit file for seven years from the date you stop paying your loan.
- Voluntary surrender: Even if you voluntarily return your car to your lender, your credit scores will be impacted, but the hit may be slightly less severe than a repossession.
- Collections: If your deficiency balance is sent to collections, you'll experience another drop in your scores and the collections account will stay on your reports for seven years from the date you originally fell behind on your debt payment.
Rebuilding Your Credit
If you owe a deficiency balance, your credit score has likely already taken a big hit from missed loan payments and other negative marks. You may feel like your score will never recover.
The truth is, no matter what your credit score is, you can always rebuild it over time. The sooner you begin adding positive information to your credit reports, the sooner you'll start gaining points. For a jump-start, sign up for Experian Boost®ø for free, and add your on-time utility, cellphone and Netflix® payments to your credit file.