Legal Definitions - deficiency judgment

A deficiency judgment is a court order that requires a borrower to pay the remaining balance of a debt after the asset used to secure the loan has been repossessed or foreclosed upon and sold, but the sale proceeds were not enough to cover the entire outstanding debt.

When a loan is secured by collateral, such as a house, a car, or business equipment, the lender has the right to take possession of that collateral if the borrower fails to make payments as agreed. The lender then sells the collateral to recover the money owed. If the amount received from the sale is less than the total debt – which typically includes the principal balance, accrued interest, and any costs associated with the repossession, storage, and sale – the lender may ask a court for a deficiency judgment to compel the borrower to pay the difference. This judgment essentially makes the borrower personally liable for the shortfall.

For a court to grant a deficiency judgment, the lender typically must demonstrate that the collateral was sold at a reasonable market price and that the relevant state laws permit such judgments for that specific type of debt.

• Example 1: Car Loan Repossession

  Imagine Sarah bought a new car with a loan of $35,000. After a year, she loses her job and can no longer make the monthly payments. The lender repossesses the car. At the time of repossession, Sarah still owes $30,000 on the loan. The lender sells the car at auction for $22,000. After deducting the costs of repossession and sale, the net proceeds are $20,000. Since the $20,000 from the sale is less than the $30,000 Sarah still owed, there's a $10,000 shortfall. The lender could then seek a deficiency judgment from a court for that $10,000, making Sarah legally responsible for paying the remaining balance.

• Example 2: Small Business Equipment Foreclosure

  A small manufacturing company, "Precision Parts Inc.," takes out a $200,000 loan to purchase specialized machinery, using the machinery itself as collateral. Due to a downturn in the economy, Precision Parts Inc. struggles and defaults on the loan. The lender forecloses on the machinery and sells it at a commercial auction. At the time of the sale, the company still owes $180,000 on the loan. However, because the machinery is highly specialized and the market is weak, it only sells for $130,000. After accounting for auction fees and other expenses, the net recovery is $120,000. The lender could pursue a deficiency judgment against Precision Parts Inc. for the remaining $60,000 ($180,000 owed minus $120,000 recovered).

• Example 3: Recreational Vehicle (RV) Loan Default

  The Rodriguez family purchased an RV for $80,000, financing it with a loan. After a few years, unexpected medical expenses make it impossible for them to continue making their RV payments. The lender repossesses the RV. At the time of repossession, the outstanding loan balance is $65,000. The lender sells the RV, but due to depreciation and a soft market for used RVs, it only fetches $50,000. After covering the costs of repossession and sale, the net amount applied to the loan is $48,000. The lender may then seek a deficiency judgment for the $17,000 difference ($65,000 owed minus $48,000 recovered), requiring the Rodriguez family to pay that remaining amount.