celebrex with aspirin

Deficiency Judgment After a Foreclosure or Short Sale?

November 30th, 2012 • Blog, Debt, Finance, Real Estate
Deficiency Judgments and California Law

Deficiency Judgments and California Law

At the forefront of every distressed homeowners mind, when considering a foreclosure or short sale, is to what extent will the lender have the right to pursue legal judgement for any deficiencies. Will a lender be able to garnish future wages in order to collect on a promissory note? Will collections agencies continue to call me after my debt(s) have been discharged? Below is a review of legal concepts common to the State of California, which can better assist in answering these and other similar important questions.

Recourse Vs. Non-Recourse

A recourse loan is one for which the lender has the legal right to pursue a deficiency judgment against the borrower. Under a non-recourse loan, the lender cannot sue the borrower for any deficiency amount. According to California Association of REALTORS®, “a deficiency is simply the difference between the outstanding loan balance and the proceeds received by the lender (or the fair value of the property). A deficiency judgment is a court order for the same amount plus costs. ” California is generally a non-judicial foreclosure and non-recourse state.

Purchase Money Mortgage Vs. Hard-Money Loans

A purchase money loan is created when financing is utilized to purchase real estate. This can refer to standard first or second mortgage loans made by banks and mortgage companies, but is most often used to describe home sellers providing financing to secure the balance of the purchase price.  In California, purchase money loans made on your primary residence are non-recourse. A hard money loan is a mortgage or trust deed executed in exchange for cash funds. This is typically a refinance, line of credit or junior loan. Hard-money loans can be subject to a deficiency judgment.

One-Action Rule

California’s One Action Rule states that there “can be but one form of action for the recovery of any debt or the enforcement of any right secured by mortgage upon real property” (California Code Civil. §726(a)). Note that a lender can commence and pursue multiple remedy at the same time and election will only be deemed irrevocable once one of them has been completed. However, effective Jan. 1, 2013, the  California Homeowner Bill of Rights (AB 278 and SB 900)  generally prohibits lenders from engaging in the practice of dual tracking, or foreclosing while the borrower has an approved short sale or pending application for a loan modification.

Deficiency Judgments in California

California Governor Jerry Brown signed SB 458 into law July, 15 2011. Under the previous law ,SB 931 of 2010, a first mortgage holder could accept an agreed-upon short sale payment as full release of liability for the outstanding balance of the loan, however, this rule did not apply to junior lien holders. SB 458 effectively extends the anti-deficiency protections provided by SB 931 to include junior liens. Such that all purchase-money loans on one- to four-unit residential dwellings (including non-owner occupied) and seller financing are exempt from deficiency judgments, with a few exceptions. Hard-money loans, or loans taken out after the home was purchased through a refinance or second mortgage can be subject to a deficiency judgment under the following conditions:

  • The lender forecloses under judicial proceedings (California Code Civil. Proc. § 726).
  • In order to obtain a deficiency judgment, a lender must apply to the court for a deficiency judgment within three months of the judicial foreclosure sale. (CCP § 726(b).)
  • If the second mortgage is hard money (refinance) and the lender has lost security for that loan through a foreclosure or short sale , making the security for the promissory note legally worthless (unsecured loan) , the beneficiary of that “sold out” junior loan can pursue a deficiency judgment (Roseleaf Corp. v. Chierighino, 59 Cal. 2d 35 (1963).

Additionally SB 458 revised CCP § 580e to provide that:

  • No deficiency shall be owed nor a deficiency judgment rendered following a short sale on a residential one-to-four unit property. (CCP § 580e(a))
  • A lender may not require a borrower/seller as a condition to agreeing to a short sale to pay money other than from the proceeds of sale. (CCP § 580e(b))

Should a lender seek to collect in such a situation, it would additionally be a violation of the California Fair Debt Collection Practices Act (Civil Code § 1788).

Negotiating Collections

Some junior loan servicers are in the practice of  heavily discounting and referring delinquent debt to a collections agency after a certain period of time. These companies are in the practice of purchasing “bad” debt at a discount, often pennies on the dollar, in an attempt to profit by collecting more money on the debt than they paid for it. Often times this can be a hurdle to closing even approved short sale as collection agencies can use aggressive negotiating tactics to attempt to get more proceeds from the sale over the amount the senior lien holder would allot .

For example lets say a collections agency buys $100,000 junior loan of bad debt for $0.10 on the dollar or $10,000. If the first trust deed in held by Fannie Mae, then the  recently standardized guidelines will limit subordinate-lien payments to $6,000 or 6 percent of the unpaid balance, whichever is less. For the collections agency to be accommodating under such circumstances would come directly out of their bottom line. As such they have no incentive to agree to release the lien from the property for a short sale. They may wish to preserve the right to pursue the entire debt thus allowing no other alternative, but to let the house go into foreclosure. Depending on the circumstances, the only way to discharge the debt might be to file for bankruptcy. Included in this filing is an automatic stay, so that foreclosure can be halted.

For more information on short sale assistance or other alternatives to foreclosure, please see our short sale page and or contact us for free consultation.

The content provided does not constitute legal/tax advice and is not intended to constitute advertising or solicitation for legal/tax services. Nothing in this Site should be construed by you as a source of legal/tax advice. You should not rely or act upon the contents of this Site without seeking advice from your own attorney/tax specialist. This information is provided for general information purposes only. IRS Circular 230 notice: In order to comply with requirements imposed by the IRS, we must inform you that any U.S. federal tax advice contained in this blog is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this blog.

There are no comments yet.

Leave a Reply