Reviewing the Southwest’s Anti-Deficiency Laws
Just in Time for the Flood
With the national mortgage settlement signed off on by a federal judge on April 6, 2012, and the banksters having been given time to bring their minions up to speed just in time for the summer buying season, it’s time to review anti-deficiency laws for homeowners. We are doing this because the settlement will speed up the termination process for homeowners in the foreclosure pipeline. Over the next few months, we can expect all the temporary loan modifications and short sale bottlenecks start to clear up. That also means the number of foreclosures will accelerate as there are a large number of homeowners who don’t fit into either the loan modification or the short sale box. For them, their outcome is foreclosure – it’s more cost effective. So when the house is foreclosed on, short sold, or the loan modification denied, what happens to the mortgage balance? Can the mortgage lender, or more accurately, the mortgage lender’s junk debt buyer come after you for more money? The answer is “it depends”. It depends on whether or not the mortgage balance is ‘recourse” or “non-recourse”. It also depends upon the sale price of the home, and whether or not the sale price creates a “deficiency”. A deficiency is a net loss on the mortgage balance after the sale of the home. If there is no deficiency, you have nothing to worry about, since there was no loss on the home. Whether a loan is recourse or non-recourse depends on state law and the nature of the loan. A non-recourse loan means that, whether or not there is a deficiency, the lender cannot go after the borrower for any loss. Non-recourse loans are entirely creations of state law. A recourse loan is defined by exclusion; if the loan is not covered by the state law non-recourse rules, it is a recourse loan. Since we blog from California, we’ll concern ourselves with the rules there, as well as in Nevada and Arizona, since there’s lots of interplay with the real estate market in those three states, and many clients had properties in all three. California Rules Any purchase money loan (the money was used in the initial sale of the home, NOT a refinance or cash out) regardless of lien priority (a first, second, third, whatever loan) or any seller financed loan secured only by the property is non-recourse, whether or not the foreclosure is judicial or non-judicial. This means for purchase money transactions, the homeowner cannot be pursued for a deficiency in California. This is true about 98% of the time. See, California Civil Code Section 580d. Naturally, there are a couple of exceptions to this – purchasers at trustee sales may pursue the homeowner for “bad faith waste” to the property. For example, if you pour concrete down your toilet after the foreclosure sale, the lender can come after you for the repair costs. It’s also subject to criminal prosecution for vandalism. The other, more interesting exception is when the foreclosing loan was either Federal Housing Administration (FHA) or Veteran’s Administration (VA) mortgages may contain a guarantee agreement under their mortgage default insurance plans (MIP). If your paperwork contains an MIP guarantee, the FHA and the VA have the right to come after you for a deficiency. Why? Because these loans are controlled by federal, not state law, and the feds have a deficiency provision. This provision is rarely applied, but it does exist. And with (1) FHA becoming the new subprime loan of choice and (2) an upcoming war with Iran to pay for (3) Congress may well decide that one way of doing so is to pursue deficiencies against foreclosed FHA loans, so stay tuned. Any debt which is not defined as non-recourse is recourse debt, which means the lender, can come after you. Basically, unless the loan is secured by a 1-4 unit residential property that you live in, the lender has recourse. This means all the investment condos you purchased in Bakersfield, Temecula and Silicon Valley before the market imploded. What about refinancing? Basically, if you took cash in the refinancing, you created recourse debt. If the refinancing was “rate and term” only, you are probably OK. If you modified a purchase money loan in a loan modification program, you are probably OK. Some loan modifications contained provisions waiving the non-recourse rules; this is probably not enforceable, but the banksters are gambling they won’t be called on this. The Really Murky Part: Short Sales and Foreclosures Foreclosures are controlled by what is called the one-action rule, California Code of Civil Procedure Section 726. This rule basically says that if you are behind in your payments, the lending bank can either sue you for damages or take the property back, sell it, and recoup as much money from the sale as possible; they cannot do both. The vast majority of the time, the bank simply forecloses on the property and moves on. If the loan was non-recourse, the foreclosing bank is done; they cannot do anything more to you. What if you have a stand-alone second, or a stand-alone HELOC, or if you’re HELOC money were used to buy really cool toys? The second’s right to foreclose on the property was eliminated when the first foreclosed; there cannot be multiple foreclosures on the same property. When the foreclosure took place, the second became unsecured debt, just like a credit card or medical bill. Their only remedy to get their money is to sue you for damages. The bad news, they have four years from the date of the foreclosure to do this. Expect to see lots of this in a few years as the foreclosed seconds are bundled up and sold to debt buyers after two or three years as homebuyers get back on their feet and have money again. As to short sales, if a second trust deed lender agrees to any payout in a short sale agreement for a residential property after July 15, 2011, there is no deficiency. The rules don’t apply to investment property. The rules don’t apply if the borrower is not a natural person (corporations, limited liability companies, partnerships, etc. are not covered). There is no protection in the event of “short sale fraud” or strategic defaults. There is also no protection if you go the concrete down the toilet route, either. Finally, the exclusion applies only to properties sold after July 15, 2011, so if you were involved in a short sale before that date, the second lender may still have the right to come after you. Conclusion If you are facing foreclosure, or wanting to do a short sale, get competent help. Neither of these are a job for amateurs. The impact of your decision will go on for years after the fact; so make the smart choice. Next Week: Nevada rules and exceptions.