Many more servicers are using deficiency judgments to recoup losses, DBRS analysts said.
They added that this is happening as loss severities increase because of the depressed U.S. housing market, mounting foreclosure inventories and lengthening liquidation timelines, particularly in terms of short sales.
The rating agency explained that a deficiency judgment is a lien placed against the borrower by the lender when a judicial foreclosure or short sale does not satisfy the amount owed on the mortgage.
For instance, DBRS said that if a borrower owes $100,000 to a mortgage lender and the proceeds after the foreclosure or short sale are $60,000, the difference of $40,000 can be filed as a judgment against the borrower.
The judgment appears, according to DBRS, on the borrowers' credit report and can affect the their ability to obtain credit in the future. Depending on the state laws, analysts said that the lender might also be allowed to take further legal action, such as garnishing wages, to pursue debt payment. Mortgage lenders do not usually pursue wage garnishment, although they wait for the borrower to try to purchase a new home and negotiate a settlement on the lien, DBRS explained.
Most states allow servicers 10 to 20 years to collect on a deficiency judgment before the statute of limitations expires. Any money from the the settlement is seen as a recovery in a securitized deal.
Some states have reacted to the dramatic rise in the pursuit of deficiency judgments by implementing laws that will stop these lenders from getting deficiency judgments in certain cases like short sales or limiting the amount of the deficiency that can be recovered to no more than the “fair market value” of the property at the time of foreclosure.
DBRS analysts believe with more borrowers share their stories of how they were led to think that when they lost their home to foreclosure or agreed to a short sale that their debt was settled with their lender more states will enact laws preventing or limiting the amount that is able to be collected in a deficiency judgment.
Considering the unprecedented level of distressed borrowers and the rise in outsourcing companies that can perform the recovery function, the rating agency expects that servicers will continue to file and pursue settlement on more deficiency judgments than in the past.
Historically, even if deficiency judgments were filed, servicers did not automatically pursue them, thinking that people who lost their homes to foreclosure would probably not have the funds needed to pay the judgment.
However, many borrowers facing foreclosure are overextended but can afford to buy a cheaper home or rent. Because these borrowers usually have some cash, the argument is that it is worth the expense of pursuing a judgment even if they are only able to recoup ten cents on the dollar.
As a result, the rating agency said that it will continue to monitor the servicing industry for trends in terms of the use of deficiency judgments as a loss-mitigation tool and its future impact on deal performance.