SB 931: New Anti-Deficiency Law Protects California Homeowners In Short Sale Situations

   By: Richard E. Korb[1]

Signed in September of 2010, California’s Senate Bill 931, pertaining to California Short Sale Deficiencies, is a new anti-deficiency law designed to protect borrowers against deficiency judgments after approving and completing a short sale. Prior to the passage of SB 931, lenders had attempted to claim entitlement to deficiency through short sales, due to prior lack of protection from anti-deficiency laws.

Background: Traditionally in California, under our “anti-deficiency laws,” when a borrower becomes delinquent on a first mortgage, the lender holding the first mortgage can foreclose on the property through a non-judicial sale under the “power of sale clause” outlined in the promissory note—but it cannot sue the borrower for any deficiency between the amount the lender received on the sale of the property and the amount owed by the borrower. (See Civil Code of Procedure, Sections 580(a) through 580(d).

For instance, John Doe purchases a home in Burbank, California for $500,000. He borrows $450,000 and defaults on the first mortgage. The bank forecloses under the deed of trust and sells the home in a trustee’s sale for $300,000 (its fair market value) when the total amount owed by John is $400,000 including accrued interests and costs of foreclosing. The amount that John owes the bank after the foreclosure is $150,000 – which is the deficiency between the sales price and loan balance. Thus, since this is a first mortgage, the lender is barred from recovering the deficiency because the loan is classified as “purchase money.” (Note that a lender on a 2^nd mortgage or refinanced loan is NOT so limited–See our article in our Business blog entitled: (“Foreclosure and Anti-Deficiency Laws in California: Can Your Lender Come After You?”)

Prior to the passage of SB 931, a “short sale” was not considered to arise under the “power of sale clause,” hence the anti- deficiency protection given a borrower on a first mortgage did NOT apply when the property was sold in a short sale (as opposed to a foreclosure). The net result was that borrowers were encouraged to give up their homes through foreclosure rather than put the home up for sale through a short sale since only with a foreclosure could they avoid a deficiency action against them.

In essence, SB931 protects borrowers on first mortgages from deficiency claims when they dispose of their property through short sales in the same respect they would be protected in the event of a foreclosure by relieving homeowners from having to repay any remaining balances due on their first mortgages.

This law will apply to all first mortgage loans secured by one to four residential units – including purchase money, hard money and refinanced loans. However, it does not prevent the lender from searching for acts of fraud or waste by the borrower.

How exactly does this law protect me from a deficiency?

If a lender provides the borrower written consent to a short sale on a first mortgage, the lender must also accept the sales proceeds as full payment and discharge the remaining balance due on the loan. SB 931 takes effect in all short sales for one- to four- unit dwellings, of which are either owner or non-owner occupied. It is not the case that the loan has to be a purchase money or non-recourse loans. These loans are any type of loan originally used to purchase a home (as opposed to a subsequent 2^nd mortgage or refinancing). The only recourse for a purchase money loan is the property or collateral itself, ergo the name non-recourse loan.

What this means for future homeowners is that banks can no longer come after borrowers for a deficiency on their first mortgage regardless of whether home is sold in a short sale or foreclosed upon; instead, the remaining amount of indebtedness will be forgiven.

Will SB 931 also protect my junior loans – 2nd and 3rd mortgages?

SB 931 does not protect junior loans or second mortgages. As a result, lenders can still pursue borrowers for the balances on these loans just as they can in the event of a foreclosure on junior loans, second mortgages and any loan used to refinance the property. This law helps homeowners by giving them other options than foreclosure, which can hurt their credit.

Conclusion: In summary, SB 931 protects borrowers undergoing a short sale from first mortgage lenders pursuing them for deficiency judgments. Borrowers under the SB 931 law are now released from liability or responsibility from all remaining debt on first mortgages when their property sells short. This law only applies to first liens, and does not protect borrowers from deficiency on second or third mortgages.

Note that this article is a simplification of complex issues regarding foreclosure and the existing anti-deficiency laws. In order to apply the new SB 931 law to your specific situation and thoroughly understand your options and their consequences, we encourage you to schedule a consultation with Richard Korb, a Berkeley-Oakland-Walnut Creek business and real estate attorney at 510-524-0903.

[1] RICHARD E. KORB is a seasoned attorney (and Cal Berkeley Alum) with 30 years of legal experience in business, real estate, foreclosure, contracts, and more. Over his legal career, Richard has successfully litigated, negotiated and resolved over 300 cases for individuals and companies of all shapes and sizes. Richard leverages his experience to assist individuals and small-to mid-sized companies with a broad spectrum of legal matters.  In addition to his legal practice, Richard is also court-approved mediator and serves on the Alternative Dispute Resolution (ADR) panel for the Alameda and Contra Costs County Superior Courts. ©2011 RICHARD E. KORB.