Can The Lender Collect The Balance Of The Loan After A Short Sale or Foreclosure
The most common question that we receive from homeowners considering a short sale or facing foreclosure is if their lender(s) will be able to collect the remaining balance after the sale or foreclosure. Not only is this the most common question, but it is also the most important item anyone in default should determine.
Foreclosure has many harsh realities. Even if you lose your home through foreclosure, you may still be personally responsible for the difference between your mortgage loan balance and what your property is worth. This difference owed to your lender is also called a deficiency judgment. California’s anti-deficiency rules may protect you from personal liability, but it depends on your particular circumstances.
Determining whether California’s anti-deficiency protections apply to your situation can get complicated. But it’s a big deal. If your lender obtains a deficiency judgment against you, you will be legally obligated to pay that amount of money. If you don’t pay, your lender may enforce this judgment by, among other things, garnishing your wages, levying your bank accounts, and attaching judgment liens against any real property you may own. Considering your personal liability after foreclosure is also critical when you’re weighing the pros and cons of foreclosure as against your other options, such as completing a short sale, getting a loan modification, or filing bankruptcy.
As of July 15th, 2011, first and second lien holders must forgive the remaining balance of a loan after a short sale is completed on a property.
On July 15th, 2011, Governor Jerry Brown signed into law Senate Bill 458 (SB458). This bill expanded the anti-deficiency protection to all second lien residential mortgages on 1-4 unit properties. The bill prevents second mortgage holders from pursuing a borrower after the closing of a short sale for the remaining balance on a loan. (One important item to note is this does not protect someone who goes through foreclosure.) Junior lenders such as a second or third mortgage, including HELOCs can no longer pursue a deficiency after a short sale.
While this is great news, this has created a new challenge for anyone with a second mortgage that has been refinanced. In many cases, this will create a circumstance that foreclosure is more beneficial to the lien holder than accepting a short sale. This is why it is so important to hire an agent that is experienced in short sale negotiations and can assist you in getting the short sale approved.
Recourse vs. Non-recourse Loans in California
In California, the loan or loans on your property will be either “recourse” or “non-recourse”
A recourse loan is one where the lender has the legal means to collect the deficiency balance from the borrower after a foreclosure. A non-recourse loan is a loan where the lender’s ability to collect is restricted to the property used to secure the loan. In other words, if the lender forecloses, it only has rights to the property and cannot come back after the homeowner for the remaining balance.
Whether a loan is a recourse or non-recourse loan depends on if the loan is the original loan used to purchase the property or if the property has been refinanced.
California recourse rules are intricate and somewhat tricky. (California statutes and case law are cited as an aid for your attorney to research your issues and facts.)
Put very simply:
If it is your original loan or loans, that were used to purchase the property, they are most likely “non-recourse”
If you have refinanced one or both loans, the loan(s) became “recourse” after the refinance.
And more in depth:
In California, purchase money loans made on your home are non-recourse. (Roseleaf Corp. v. Chierighino, 59 Cal. 2d 35, 41 (1963) and Spangler v. Memel, 7 Cal. 3d 603, 610, and 612 (1972).) A “purchase money” loan is one where the money went from the lender, to escrow, and then to the seller or to pay purchase closing costs. If the borrower never refinanced and the property is still encumbered by the original purchase money deed, the anti-deficiency protection remains. (Foothill Village Homeowners Ass’n v. Bishop, 68 Cal. App. 4th 1364, 1367 n.1 (1999).)
HELOC and Home Equity Loans
During the housing boom of the mid-2000s, people who had little or no money to bring to the table as a down payment were able to purchase homes through various creative financing arrangements. Typically, two loans were used to purchase the property. A first mortgage for 80% of the balance and a second loan for the remaining 20%. The second mortgage for the 20% was either a Home Equity Loan or a Home Equity Line of Credit (HELOC).
Second mortgages may or may not be recourse loans under California law. If the second mortgage was taken out at the time of sale and was used as purchase money loan then it is a non-recourse loan (Brown v. Jensen, 41 Cal.2d 193 (1953).) However, if the second mortgage was financed after the initial purchase of the property and is on a second deed, then Section 580b does not apply. Similarly, Section 580b also does not apply when the borrower has refinanced the property to take out additional equity or obtain financing at better terms (Union Bank v. Wendland, 54 Cal. App. 3d 393, 400 (1976).)
A Home Equity Line of Credit (HELOC) is similar to a credit card secured by property. No money changes hands until the consumer draws on the HELOC. If the HELOC was taken out at the time of purchase, for the purpose of buying the property, the loan is considered a purchase money loan.
In California, the lender can foreclose on a property either judicially through a civil lawsuit, or a non-judicial foreclosure through a “trustee’s sale”. Most lenders in California opt to foreclose by a trustee’s sales.
It will almost always be the first mortgage that will initiate the foreclosure process and take back the property. Under California law, if a lender takes back the property through a trustee’s sale, they cannot pursue a borrower for a deficiency balance resulting from a first mortgage used to purchase a residence. (Cal. Code Civ. Proc. § 580b)
If you have two mortgages and the first mortgage forecloses through a trustee’s sale, the unpaid second mortgage whose security interest was wiped out may be able to still pursue you after the foreclosure, for the full balance of the loan IF it is a recourse loan. Many people are not aware of this and feel that they will be able to just walk away after the foreclosure.
In most cases with a short sale, we are able to negotiate with a lender that they will not pursue the homeowner after the short sale closes. This is one of the main benefits of completing a short sale.
Other Instances The Lender May Pursue You
Loan Fraud: If you made any misrepresentations to your lender, you may be personally liable for loan fraud regardless of the anti-deficiency protections.
Bad Faith Waste: If you intentionally damage or destroy the property by action or inaction, you may be personally liable for committing bad faith waste, regardless of the anti-deficiency protections.
We are not attorneys. The information provided below is for informational purposes ONLY. It will serve as a starting point to further investigate your loan(s) and determine if you may be liable for the balance owed. We HIGHLY RECOMMEND that you consult a real estate attorney regarding your situation before you consider a short sale, deed-in-lieu-of-foreclosure, or foreclosure.
Contact us today to if you would like to discuss your situation and learn more about the options that are available to you.