New and Recent Anti-Deficiency Laws Affecting Homeowners

July 20, 2012

Short Sales

In 2011, two important California laws were passed affecting homeowner rights involving short sales.

Effective January 1, 2011, a new law prohibited lenders from pursuing a deficiency judgment under a note secured by a first deed of trust or first mortgage for residential properties with four or fewer units after a short sale approved by the lender. However, this law applied to neither junior loans nor to borrowers who are corporations or other business entities, political subdivisions of the state or to claims the lender could bring against the borrower or other parties for fraud, waste or other causes of action.

Subsequently, effective July 15, 2011, a new law expanded the January 2011 law. This new law is more generous to borrowers than the January 2011 law in that it covers not only a first deed of trust or first mortgage, but also junior loans. In addition, this law prohibits lenders from seeking any payment from borrowers aside from payment of the proceeds of the short sale. This is an important change as, prior to the enactment of the July 2011 law, lenders often demanded payment from borrowers as a condition for allowing short sales to proceed. In addition, junior lenders had previously been permitted to seek deficiency judgments against borrowers after the short sale.

Similar to the January 2011 law, the new law does not prevent lenders from obtaining damages against the borrower or other parties for fraud, waste or other grounds. In addition, the new law is inapplicable to borrowers who are corporations, limited liability companies, limited partnerships, political subdivisions of the state, and to any deed of trust, mortgage or other lien to secure payment of bonds issuable by the Commissioner of Corporations or certain public utilities.

Prior to the passage of these new laws, homeowners would sometimes elect to have their homes foreclosed, rather than go through with a short sale. They often did so in the hope of obtaining protection under California anti-deficiency laws prohibiting some lenders from pursuing deficiency judgments after non-judicial foreclosures of certain properties. Many other owners who mistakenly believed that lenders were not permitted to pursue deficiency judgments against them after the short sale, would find themselves unpleasantly surprised after they were hit with a lawsuit from the lender for the deficient amount.

With the new anti-deficiency laws most homeowners can elect to short sell their homes without fear of a deficiency lawsuit because lenders who approve the short sale typically cannot pursue deficiency judgments against the borrowers in the absence of fraud, waste or another cause of action.

Foreclosures

In July 2012, California passed Senate Bill 1069, another significant law, effective January 1, 2013, protecting certain homeowners from anti-deficiency judgments after foreclosure.

Currently, before the new law takes effect, homeowners of residential properties containing up to four units that are also owner-occupied are usually protected from deficiency judgments arising from purchase money loans secured by the property after foreclosure. Similarly, homeowners are generally protected from deficiency judgments in seller financing situations. However, if the homeowner has refinanced his purchase money loan, he could lose protection from the anti-deficiency laws.

Under the new law, a homeowner who has refinanced his purchase money loan after January 1, 2013 may still be able to avoid a deficiency judgment and personal liability after foreclosure. But the new law excludes from anti-deficiency protection any “new advance,” also known as “cash out,” “which is not applied to any obligation owed or to be owed under the purchase money loan, or to fees, costs, or related expenses of the credit transaction.” (Code of Civil Procedure Section 580b(c)). In addition, the new law provides that “any payment of principal shall be deemed to be applied first to the principal balance of the purchase money loan, and then to the principal balance of any new advance, and interest payments shall be applied to any interest due and owing.” (Code of Civil Procedure Section 580b(c)).

Tax Consequences

Finally, even though homeowners may be protected from deficiency judgments by going through with a short sale or foreclosure, individuals may suffer tax consequences for the deficient amounts. For this reason, homeowners should proceed with caution, consulting with a real estate lawyer and their tax advisor before making any decisions.

© 2012 Szeto Law Group. These materials do not constitute legal advice and are for general informational purposes only. They may be reproduced for personal use and for non-commercial distribution. All copies must include this copyright statement.
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