California has been among the states hardest hit by declining real estate values. Many homeowners now find themselves “underwater,” or owing more on their home than it is worth. According to a recent report from research firm First American Home CoreLogic, 37.4 percent of California home mortgages are underwater. In such cases, if homeowners cannot make their payments and the home is foreclosed, or if they are forced into a “short sale” whereby they sell the home for significantly less than the amount of their mortgage, many wonder how they can possibly pay back the bank. Fortunately, California’s laws have long protected homeowners in these situations.
Since 1933, California has had anti-deficiency statutes, which keep creditors (banks) from over-valuing properties and protect landowners in times of decreasing property values. Here’s how they work: If the purchase of a property is financed with a mortgage for $300,000 and the property is later foreclosed or sold at a value of $200,000, the difference of $100,000 is called a deficiency. Although the lender would like to require the property owner to pay back the $100,000 deficiency, in many cases the owner isn’t required to do so.
When is a property owner protected? That depends on how the bank proceeds. Generally, the bank has three options. The first is judicial foreclosure, under which the property owner is responsible for the deficiency. Fortunately for California homeowners though, judicial foreclosure often takes years, making it an unattractive option for banks. Additionally, under judicial foreclosure, the original property owner has the right to buy back the property following the sale (this is called the right of redemption). For these reasons, banks will often not pursue judicial foreclosure.
The second option a bank might pursue is non-judicial foreclosure, also known as a trustee’s sale. In this process, the bank issues a Notice of Default, waits 90 days, issues a Notice of Sale, waits 21 days, and can then sell the home. Because the process is much faster, banks tend to favor it over judicial foreclosure. But the good news for homeowners is that under non-judicial foreclosure, California’s anti-deficiency statutes protect them from being forced to pay the difference if the home sells for less than the amount of the original mortgage. However, this protection only applies when the mortgage is for “purchase money” – in other words the original cost of the home. It doesn’t apply when the homeowner has refinanced their mortgage.
The third option a bank might select is to agree to a short sale. Under a short sale, the homeowner sells the property with the bank’s agreement that the resulting sale will satisfy the mortgage, even though it may be for less than the original amount of the loan. Although banks have traditionally been reluctant to agree to short sales, in the wake of the real estate market collapse short sales have helped banks get troubled loans off their books and spurred the housing market.
Some banks have sent letters to homeowners asserting that if they have the rights to pursue the homeowner for funds above that obtained in a short sale, they are not waiving those rights. Naturally, homeowners considering a short sale are concerned that they’re going to be responsible for the difference between the short sale and the original loan.
But here again, California’s anti-deficiency legislation may provide some relief. The language of the statute does not expressly limit it to use in non-judicial foreclosure. Furthermore, California’s Supreme Court has stated that the statute is to be interpreted in light of its legislative purpose, which is to “discourage land sales that are unsound because the land is overvalued and, in the event of a depression in land values, to prevent the aggravation of the downturn that would result if defaulting purchasers lost the land and were burdened with personal liability.” Given the current real estate climate and the reliance on short sales to spur the depressed housing market, homeowners may increasingly look to the anti-deficiency statute for relief under short sales, as well.
Although California law limits lenders to “one action” to recover its debt, a bank looking to preserve its options might commence proceedings for both judicial foreclosure and non-judicial foreclosure, while at the same time discuss authorizing the homeowner to conduct a short sale. Because of the complex issues involved, homeowners should talk to a seasoned California real estate attorney who understands the issues and can make sure their rights are protected.
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Anti-Deficiency statutes:
California Code of Civil Procedure §§580a-580d
Foreclosure statutes & one action rule:
California Code of Civil Procedure §§ 726-730
Cases:
Roseleaf Corp. v. Chierighino, 59 Cal.2d 35, 41, 378 P.2d 97, 100 (1963):
Section 580b was apparently drafted in contemplation of the standard purchase money mortgage transaction, in which the vendor of real property retains an interest in the land sold to secure payment of part of the purchase price. Variations on the standard are subject to section 580b only if they come within the purpose of that section.
Crookall v. Davis, Punelli, Keathley & Willard, 65 Cal.App.4th 1048, 1061, 77 Cal.Rptr.2d 250, 257 (Cal.App. 2 Dist., 1998):
The Spangler court announced a two-part test to determine whether section 580b applies. First, the court must decide whether the secured loan is a standard purchase money transaction to which section 580b automatically applies. (7 Cal.3d at p. 611, 102 Cal.Rptr. 807, 498 P.2d 1055.) If it is not, then the court must analyze the factual setting of the transaction to determine whether the transaction comes within the purposes of section 580b. (Id. at pp. 611-612, 102 Cal.Rptr. 807, 498 P.2d 1055.)
Spangler v. Memel, 7 Cal.3d 603, 612, 498 P.2d 1055, 1060 (1972):
We, therefore, conclude that the subordination clause situation is sufficiently different from the standard purchase money mortgage situation to *612 remove it from automatic application of section 580b and to require an analysis of this factual setting in light of the purposes of section 580b in order to determine the applicability of that section.
In Roseleaf, we described the purposes of section 580b as follows: ‘Section 580b places the risk of inadequate security on the purchase money mortgagee. A vendor is thus discouraged from overvaluing the security. Precarious land promotion schemes are discouraged, for the security value of the land gives purchasers a clue as to its true market value. (Citation.) If inadequacy of the security results, not from overvaluing, but from a decline in property values during a general or local depression, section 580b prevents the aggravation of the downturn that would result if defaulting purchasers were burdened with large personal liability. Section 580b thus serves as a stabilizing factor in land sales.’ (Roseleaf Corp. v. Chierighino, Supra, 59 Cal.2d 35, 42, 27 Cal.Rptr. 873, 877, 378 P.2d 97, 101.)
In Bargioni, we restated and summarized the purposes of section 580b thusly: ‘The purposes are to discourage land sales that are unsound because the land is overvalued and, in the event of a depression in land values, to prevent the aggravation of the downturn that would result if defaulting purchasers lost the land and were burdened with personal liability.’ (Bargioni v. Hill, Supra, 59 Cal.2d 121, 123, 28 Cal.Rptr. 321, 322, 378 P.2d 593, 594.)
Treatises:
CAJUR DEEDSTRUST § 328 Deficiency judgments in general
CAJUR DEEDSTRUST § 342. Deficiency judgment generally not allowed after sale under power in purchase-money transaction
CAJUR DEEDSTRUST § 343 Purpose and effect of antideficiency legislation
Business Week article on Short Sales
A Little More on the One Action Rule
Two other interesting blog posts from the same author:
http://practicalcounsel.wordpress.com/2009/09/03/
http://practicalcounsel.wordpress.com/2009/09/11/
If you have any questions about Foreclosure Laws in California, please click here.
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