DEFINITION of ‘Deficiency Balance’
The amount owed to a creditor if the sale proceeds from the collateral that secured a loan is less than the outstanding loan balance. A deficiency balance generally arises from distressed situations where an asset has to be sold to recover the balance outstanding on a loan, such as home foreclosures, short sales and car repossessions. A deficiency balance has to be addressed by the borrower, as it constitutes a debt obligation that must be repaid to avoid damage to the borrower’s credit history.
BREAKING DOWN ‘Deficiency Balance’
For instance, assume the balance outstanding on a car loan is $15,000, and the borrower is unable to service the loan. The lender repossesses the car and sells it at an auction for $10,000. The deficiency balance in this case is $5,000.
As another example, if the amount owed on a delinquent mortgage is $300,000, and the bank that holds the mortgage forecloses and sells the property for $250,000, the deficiency balance is $50,000.
As these examples demonstrate, the size of the deficiency balance is directly proportional to the value of the asset. In the case of a vehicle loan, a deficiency balance can perhaps be addressed by cutting personal expenses and using savings, but in cases where real estate is involved and deficiency balances run into tens of thousands or even hundreds of thousands, there may be few options available to the borrower.
The key point to remember is that you are on the hook for the full amount of the loan taken to purchase an asset. This should be borne in mind if you are tempted to live way beyond your means by buying an expensive car (which is prone to rapid depreciation) or upscale vacation condo.
Another point to keep in mind is that repossessed assets are typically sold well below their air market value in an auction situation, so it may be best to explore alternative means (such as a private sale) to receive close to market value for the asset, in order to reduce the dollar amount of the deficiency balance.
It should be noted that the laws regarding deficiency balances in the case of a foreclosure or short sale involving a primary residence are quite complex, and someone who is confronted with such a situation should seek legal advice from a qualified practitioner.