Almost all real estate loans – commercial and residential – require a personal guarantee. While this aspect of the loan is possibly the single most important facet of a real estate loan that borrowers should understand, it also tends to be one of the least discussed and least understood parts of real estate lending.

Defined simply, a deficiency judgment is a court ruling allowing a lender to collect additional money from the borrower when the sale of the borrower’s property is not enough to cover the borrower’s outstanding balance. However, it is easiest to understand deficiency judgments using an example. 

Deficiency Judgments in Residential Loans

There are 2 ways that a borrower may end up being personally liable for a real estate loan. The most common way is by signing a promissory note (therefore being the “borrower”) related to a real estate loan. In residential loans, the borrower is almost always the party that owns the home. By signing the promissory note they become liable for repayment of the full amount owing to the lender. In Colorado it is up to the lender if they want to take the house, pursue the individual, or both. In other jurisdictions (such as California) the lender can do one or the other but not both.

Colorado Homeowner Deficiency Judgment Example

Let’s follow this example for a Colorado real estate loan: You buy a home for a sale price of $400,000 and make a 20% down payment. You borrow 80% or $320,000 from XYZ Lender. A decline in residential home values lowers the value of your home to $300,000. You decide you don’t want to make your mortgage payments anymore and stop making them. XYZ Lender forecloses against your home (which is a process that takes about 5 months in Colorado) and by the time your foreclosure reaches the sale date set by the Public Trustee, you now owe XYZ Lender $350,000 – part of which is delinquent interest and part of which is legal and other fees the lender has incurred that you, as the borrower, are responsible for. At the Public Trustee Sale the Lender “bids” $300,000 (which may be the fair market value of the property at that date). Typically this leads to the Lender taking the title to your house. 

Are you off the hook?  No – your problems may just be beginning.

You owe the Lender $350,000 but the Lender “bids” $300,000 leaving a $50,000 “deficiency balance”.  The house pays off $300,000 of your mortgage loan but you still owe the Lender the $50,000.  If the Lender wishes to do so, they will file a deficiency lawsuit against you asking the Court to create a judgment of $50,000 against you (and your spouse if they also signed the Promissory Note). You do not have much of a defense to this lawsuit since you signed a Note and you owe the money. If the judgment is “entered” it then becomes a “deficiency judgment”.

The Lender can proceed to garnish your salary – seize any money in any bank accounts (that they can find) and if they want to be very aggressive, seize and sell all of your personal property – your car – your artworks – anything you own to pay off this outstanding debt. This doesn’t happen very often – but legally it could.

Can you Negotiate With Your Residential Lender?

Some borrowers try to negotiate with their Lender to see if the Lender will waive or lower the amount of the deficiency but you are basically at the mercy of the Lender. It is completely up to them. You don’t have any options in a residential loan to avoid these unfortunate possibilities. No bank or company is going to fund a residential loan without your personal guarantee. 

Your only defense is to understand clearly before signing loan documents what they mean and that it can lead to a deficiency judgment if you don’t pay per the terms of the agreement.

How Deficiency Judgments Work For Commercial Loans

Now that we’ve discussed what personal guarantee can mean in a residential loan, we can discuss what they can mean in a commercial loan. Signing a personal guarantee is much more complicated for a borrower of commercial real estate loans and it is highly important to understand what it means and how it works.

Commercial Loan Deficiency Judgment Example

The Title to most commercial real estate now is held by an LLC. For purposes of this blog, we will assume this to be the case in our example.

Let’s assume that you are purchasing a warehouse for $1,000,000, making a $200,000 cash down payment, and borrowing the remaining $800,000 from your bank secured by a first deed of trust. In addition to having you sign a Promissory Note for $800,000 and giving the bank a deed of trust, the bank is almost always going to require that you sign a “Guarantee Agreement”. This Guaranty makes you personally liable for the real estate loan that is secured by the commercial property owned by your LLC.

If your real estate loan is $5,000,000 or more you may be able to get what is called a “non-recourse” loan which means that you as an individual are not responsible for the real estate loan to the LLC that you manage. Even if this option is offered, most lenders have certain “carve-outs” (for example for fraud) that limit the extent of the non-recourse feature. However, bank or institutional lenders of commercial loans under several millions of dollars are not as likely to offer a non-recourse option.

If the bank ends up taking foreclosure action on your $800,000 loan it can pursue many options including some that most borrowers are not aware of. The bank can follow the typical route and foreclose which takes about 5 months. At the end of the foreclosure process the bank must tender a “bid” to the Public Trustee for whatever amount they feel they can substantiate. Also, don’t forget the total amount you will owe the bank can go up exponentially since they are entitled to charge delinquent interest and add in all legal as well as other costs. If you owed $800,000 when the foreclosure started, that may increase to $900,000 or more when the property goes to foreclosure sale.

The bank can bid $700,000 and then assert a $200,000 deficiency judgment against the guarantor (i.e. you). You do have the ability to go into Court to make the bank prove their $700,000 bid was reasonable compared to the fair market value of the foreclosed property. However, this can be a difficult and expensive legal process for the borrower to pursue. If the Court grants the bank’s motion for a deficiency judgment, then the bank can attempt to attach your individual bank accounts, garnish your salary if you are employed, and in general go after any personal property or other real estate property that you own in your own name. The bank may not do this, but they have full legal rights to do so. Guarantors of commercial real estate loans need to carefully understand what they are doing before they agree to sign these documents.

Another option that a bank may follow is to sue the Guarantor under the personal guarantee right away and foreclose later. There are a number of ways that this option can play out. It is not common, but it is legally possible.

Get a Commercial Loan with Montegra Capital Resources

Montegra Capital has a proven track record with over 50 years as a trusted source for hard money and bridge loans in Colorado. We specialize in financing commercial real estate loans that banks and institutional lenders are not able to fund. Check out our loan types and contact us today to learn more.

Disclaimer / This blog is written by Bob Amter drawing on his over 40 years of private money lending in Colorado.  Bob is not an attorney and any legal information discussed in this blog is Bob’s own personal understanding of certain lending practices and is not intended as legal advice for any of his readers.  Bob not only advises borrowers who are working with Montegra to use an attorney to represent them – he requires it.