What Is a Deficiency Balance?

If you apply for a secured loan, you’ll be asked to provide collateral, or something of value you possess, to back the loan. Mortgages and auto loans are common types of secured loans, and some personal loans are secured, too. With a mortgage or auto loan, the collateral is the home or car you’re buying. For a personal loan, the collateral might be a vehicle you own. If you default on a secured loan, the lender has the right to take possession of the collateral and sell it to collect the amount you owe.¹

If selling the collateral doesn’t cover the entire amount due, you may owe a deficiency balance, which is the remaining amount.² In this article, we’ll explore what happens when you owe a deficiency balance, ways to pay it off, potential financial repercussions and how to avoid owing this balance in the future.

What does it mean to owe a deficiency balance?

A borrower who has defaulted on a loan owes a deficiency balance if the creditor’s sale of their collateral doesn’t cover the amount they still owe. In some cases, the lender may also need to add related costs to the deficiency balance. For example, a borrower may be charged for towing if the lender repossessed their car.^3,4 Depending on the terms of the loan, the lender may also add administrative fees to the deficiency balance.⁵

Typically, the lender sends a written notice, called a deficiency balance letter, explaining what the borrower still owes and how to pay.⁶

Understanding deficiency balances

Here’s a simplified example of how a deficiency balance works in practice.

• You have a secured auto loan with a balance of $12,000.
• Your lender sells your repossessed vehicle for $8,000, leaving a difference of $4,000.
• They also pay $500 to tow and sell the car and require you to cover that cost.

You would be responsible for paying a deficiency balance of $4,500 in this example.

How to pay a deficiency balance

If you end up with a deficiency balance after defaulting on a loan and having your collateral repossessed, your lender will notify you of the amount due in a deficiency balance letter. If you still owe a deficiency balance, there are ways to pay back what you owe.

Lump sum payment

The most direct way to pay off your deficiency balance would be to make a lump sum payment to the lender. By paying the deficiency balance in full, you are paying back your debt and preventing further damage to your credit score.

Payment plan

If you can’t pay the full balance, reach out to your lender immediately to discuss the next steps. You may be able to start a payment plan, which would allow you to make payments each month to pay down the debt while keeping the lender from selling the debt and sending it to a collection agency. Your lender may be willing to work with you to find alternative payment solutions.⁷

What if you don’t pay a deficiency balance?

If you don’t pay the deficiency balance and can’t reach a payment agreement with your lender, the lender may send the debt to a debt collector or sue to collect what they’re owed through wage garnishment or liens on other eligible property. Wage garnishment is when part of your paycheck is withheld to repay the debt, and a lien is a legal claim to your vehicle, home or other property.^8,9 The timelines for these steps vary based on your state and the type of loan. If you’re sued for a deficiency balance, you may want to contact a lawyer to better understand your options.

Special considerations for foreclosure

Some states have anti-deficiency laws that limit or prevent lenders from collecting the remaining balance after a foreclosure.¹⁰ However, anti-deficiency laws vary widely depending on the state where you live and may have specific rules. For example, the law may only apply to certain types of property or loans.¹¹ If you’re facing a deficiency balance on a mortgage and aren’t sure whether it’s legal, a lawyer can help.

How deficiency balances impact your credit

Having a deficiency balance doesn’t directly impact your credit score.¹² However, the circumstances that led to the deficiency balance, like missed or delinquent payments and defaulting on the loan, will cause a significant drop in your credit score.¹³ Your credit score will take another hit if you’re unable to pay a deficiency balance and the lender sends the debt to a debt collector, which will show up on your credit report for up to seven years.¹⁴

Foreclosures and repossessions are also reported to credit bureaus and can hurt your credit score for up to seven years. The impact is most significant in the first months and years after a foreclosure or repossession.^15,16,17

Over time, adopting responsible financial habits, like making timely payments and paying down your debt, could help you improve your credit score after a deficiency balance occurs.

Strategies to avoid a deficiency balance

While you can’t predict how life events might impact your finances in the future, there are actions you can take to reduce your chances of ending up with a deficiency balance:

• Make consistent payments: Keeping up with your loan payments is the best way to avoid missed payments, late fees, and defaults. You can set up automatic payments, so the payments are automatically drafted from your bank account on time each month. Just remember to have enough funds available in your account to cover the payment.
• Communicate with your lender right away: If you’re struggling to make payments, reach out as soon as possible. Your lender might offer options like allowing you to pause or lower your payments for a period of time, called “forbearance.”
• Understand your loan terms: Take the time to review your loan agreement, so you know what happens if you miss a payment. Learn what actions your lender can take if you default, such as repossessing your collateral, sending your account to a debt collector, or taking legal action. Some loan agreements, including OneMain’s, explain that, depending on state law, the lender may sue the borrower to recover the shortfall if the sale of the collateral doesn’t cover what the borrower still owes.

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Come back stronger after a deficiency balance

Facing a deficiency balance may feel like a major setback, but don’t let it discourage you. By working closely with your lender, you can find a path forward that helps you resolve the situation to minimize potential credit damage.

Sources

1 https://www.investopedia.com/terms/d/default2.asp
2, 7, 8 https://www.investopedia.com/terms/d/deficiency-balance.asp
3 https://consumer.ftc.gov/node/77396
4 https://www.consumerfinance.gov/ask-cfpb/what-happens-if-my-car-is-repossessed-en-865/
5, 6 https://www.investopedia.com/terms/d/deficiency-balance.asp#toc-what-happens-if-you-dont-pay-a-deficiency-balance
9 https://www.bankrate.com/mortgages/what-is-deficiency-judgment/#what-is
12, 13, 14 https://www.experian.com/blogs/ask-experian/what-happens-if-i-dont-pay-a-deficiency-balance/
10 https://content.next.westlaw.com/practical-law/document/If98a85681c9011e38578f7ccc38dcbee/Anti-Deficiency-Laws:
11 https://www.legalmatch.com/law-library/article/anti-deficiency-laws.html
15 https://www.experian.com/blogs/ask-experian/how-does-a-foreclosure-affect-credit/
16 https://www.equifax.com/personal/education/personal-finance/articles/-/learn/what-is-reposession/
17 https://www.experian.com/blogs/ask-experian/how-to-fix-credit-after-a-car-repossession/