Foreclosure And Anti-Deficiency Laws in California: Can Your Lender Come After You? By: Richard E. Korb[1]
Your house is underwater, upside down, facing foreclosure, etc. Your house is now valued less than the loan you used to afford it. This means the proceeds of its sale will not be enough to pay back the loan on the home (your mortgage) in full. What should you do?
The first step is to weigh your options. Should you walk away from the mortgage obligation? If the lender forecloses and then sells your home for less than the amount you owe on the home’s mortgage (loan), will the lender be able to sue you for the difference, otherwise known as the “deficiency?”
The options are not picture perfect, but there are options and the laws in your state may offer some protection. California has what is termed “Anti-Deficiency Laws” detailed in the Civil Code of Procedure, Sections 580(a) through 580(d). Deficiency refers to the gap between the market value of the house and the value of loan at the time of loan repayment, meaning the amount of money that you would still owe to the lender after a foreclosure sale.
Anti-Deficiency laws can protect the borrower. Under certain circumstances, the borrower is no longer bound to pay this unpaid debt to the lender after foreclosure. In legal terms, the first trust deed seller cannot seek adeficiency judgment or the outstanding loan balance against the borrower or sue the borrower for the deficiency. However, these laws do not protect the borrower from be sued for fraud or waste, failure to maintain the property.
How does the law apply to your situation?
Whether deficiency protection applies to your situation depends on the type of property you own, the type of loan you have, and the type of foreclosure.
The first two conditions are found in Code of Civil Procedure (CCP) 580(b), otherwise known as the Purchase Money Prohibition:
“No deficiency judgment shall lie in any event after a sale of real property or an estate for years therein for failure of the purchaser to complete his or her contract of sale, or under a deed of trust or mortgage given to the vendor to secure payment of the balance of the purchase price of that real property or estate for years therein, or under a deed of trust or mortgageon a dwelling for not more than four families given to a lender to secure repayment of a loan which was in fact used to pay all or part of the purchase price of that dwelling occupied, entirely or in part, by the purchaser.
Where both a chattel mortgage and a deed of trust or mortgage have been given to secure payment of the balance of the combined purchase price of both real and personal property, no deficiency judgment shall lie at any time under any one thereof if no deficiency judgment would lie under the deed of trust or mortgage on the real property or estate for years therein.”
What does this statutory language mean? First, in California, the mortgage loan must apply to an owner-occupied, residence between one to four units in size. The property must be one where you spend the majority of your time, otherwise known as your primary residence. This clause thus excludes vacation homes and investment properties. The latter part of the clause excludes dwellings with more than 4 units.
The second condition in CCP 580(b) concerns the loan itself. California’s anti-deficiency laws only apply to “purchase money” or non-recourseloans. These loans are any type of loan used originally to purchase your home. The only recourse or security for a purchase money loan is the property or collateral itself, hence the name non-recourse loan. Borrowers of recourse loans in California are not protected by Anti-Deficiency laws.
In the process of mortgaging a home, many home-owners take out second mortgages or loans acquired after the initial mortgage at time of purchase of the home. Unfortunately for these home-owners, the first loan or the purchase money loans are often not the problem. Instead the difficulty lies in paying back second mortgages or home-equity lines of credit (“HELOCs”) made after the original purchase.
With these secondary loans, otherwise known as Recourse loans, the anti-deficiency protection is removed. Recourse loans refer to additional financing or loans acquired after the initial mortgage at time of purchase of the home. This would include home-equity loans and second mortgages or a “piggy-back mortgage”, refinanced loans and home-equity lines of credit (HELOC). States with this condition in their statutory language are known asNon-Recourse States. Any type of loan taken out at the point of property purchase is protected by the Anti-Deficiency laws, but not additional financing or loans acquired later.
In most states, if the loan that is being foreclosed on is a loan that was obtained for the purpose of purchasing the property, then no deficiency is allowed. It doesn’t matter if it’s a first, second or third. It doesn’t matter if it’s classified as a “HELOC,” a “seller carry back,” or, ultimately, a “sold out junior.” Purchase money is purchase money.Note that in some states (such as California) non-recourse laws apply only to “purchase money” loans (i.e. original home loans that are used to purchase property). Almost all HELOCs and home equity loans are considered recourse loans and lenders for these loans may sue borrowers to recoup loss. (Except in some cases where the second mortgage lender forces the foreclosure).
Example: Homeowner buys a house for $300,000, with a first for $200, and a second for $60,000, both put on the property at the time of acquisition. If the first forecloses, both lenders are barred from getting a deficiency because both loans are classified as “purchase money.” However, where the borrower has refinanced the original purchase money loan, or got a later home equity loan, that later loan is not a purchase money loan and could form the basis for a deficiency if the other anti-deficiency rules don’t otherwise apply.”
The only type of non-purchase money loan that may be protected from a deficiency judgment are loans used to improve your property. The third condition is found in CCP 580(d), termed the“Private Sale Bar:”
“No judgment shall be rendered for any deficiency upon a note secured by a deed of trust or mortgage upon real property or an estate for years therein hereafter executed in any case in which the real property or estate for years therein has been sold by the mortgagee or trustee under power of sale contained in the mortgage or deed of trust.”
Most home loans have a “power of sale clause,” which means that the lender can take the property back through a non-judicial foreclosure or trustee’s sale. (See our article in our Business-Real Estate blog discussing Non-Judicial Foreclosure vs. Judicial Foreclosure). A lender that chooses to invoke the power of sale clause and pursues a non- judicial foreclosure (outside of the courts) cannot pursue a deficiency judgment against the borrower.
A lender can only sue a borrower for deficiency if he or she first files a judicial foreclosure. In this scenario, if the first lender forecloses and the second loan is a non-purchase money loan, the second lender can seek a deficiency judgment from the borrower. Thus you will still be accountable for the entirety of the second loan and all other additional financing, unless those loans were taken out at the point of purchase. However, if the lender of the first purchase money loan and the second non-purchase money are the same lender then the lender cannot seek the deficiency for the 2nd loan.
Please note that this article is a simplification of complex issues and only covers the clauses that are most frequently used. To apply these laws to your specific situation and fully understand your options and their consequences, we encourage to you arrange a free consultation withRichard Korb, a Berkeley-Oakland–Walnut Creek business/real estateattorney at 510-524-0903.
[1] RICHARD E. KORB is a seasoned attorney with 30 years of business and real estate litigation and transactional (contracts) experience. Over his legal career, Richard has successfully litigated and resolved over 300 court cases in the fields of contract law, real estate, employment, unfair competition, bankruptcy and general civil law and he has drafted and negotiated over 250 contracts and licenses for large and small companies alike. Richard leverages his experience as a former partner in a 100-person law firm and chief counsel for a public software company to assist individuals and companies, from start-ups to multi-nationals, with a broad spectrum of legal matters. In addition to his legal practice, Richard is a court-approved mediator and serves on the Alternative Dispute Resolution (ADR) panel for both the Alameda and Contra Costs County Superior Courts. ©2011 Richard Korb
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