In some states, mainly judicial, you may end up facing a possible deficiency judgment after a foreclosure or short sale. For residential foreclosures in California, the majority of borrowers will not be subject to a possible deficiency judgment. But with anything that sounds too good to be true, there are exceptions to this rule.
Homeowners are often forced into foreclosure due to the fact they are underwater (i.e. negative equity) and have no other choice but to walk away from their property. Because of this, the amount owed to the lender is often substantially higher than the foreclosure auction price. If the sales price of the foreclosure or short sale does not satisfy the outstanding balance of the loan, this amount is referred to as the deficiency.
For example: The outstanding balance for a first mortgage is $100,000, with $35,000 remaining on a junior loan, but the home only sells for $100,000 at the foreclosure auction. The deficiency balance in this case is $35,000.
Certain states allow foreclosing lenders to pursue the borrower after the foreclosure or short sale to collect on this amount. If the lender pursues a deficiency judgment and it’s approved by the courts, the lender may seek to garnish the borrower’s wages or levy bank accounts to collect on the $35,000 (amount used in example above).
Non-judicial VS. Judicial Foreclosures
California foreclosure laws allow the lender to use judicial or non-judicial proceedings. Judicial foreclosures are always handled through courts and the process can be very lengthy and costly for the lender, whereas non-judicial foreclosures are administered through the Trustee and is the most common route chosen for residential foreclosures.
Non-judicial Foreclosure: A foreclosing lender is prohibited from seeking the deficiency balance in California using the non-judicial foreclosure process (CCP § 580d). This law does not apply to junior liens (mainly HELOCs) or properties with more than 4 units. Since virtually all residential foreclosures are non-judicial, most borrowers will not face a possible judgment in the future.
(CCP § 580d) No judgment shall be rendered for any deficiency upon a note secured by a deed of trust or mortgage upon real property or an estate for years therein hereafter executed in any case in which the real property or estate for years therein has been sold by the mortgagee or trustee under power of sale contained in the mortgage or deed of trust.This section does not apply to any deed of trust, mortgage or other lien given to secure the payment of bonds or other evidences of indebtedness authorized or permitted to be issued by the Commissioner of Corporations, or which is made by a public utility subject to the Public Utilities Act.
Judicial Foreclosure: Very rare in California for residential properties. If used, the lender is not prohibited from seeking a deficiency judgment, however they must seek to do so by filing a complaint with the courts within three months of the foreclosure. This is not common due to the lengthy and expensive process. The courts will hold a hearing to determine the fair value of the foreclosed property.
Even when the lender chooses the judicial foreclosure process, they cannot seek a judgment if the property is 1-4 unit owner-occupied (purchase money loan) or the loan was refinanced (no longer purchase money) on or after January 1, 2013.
(CCP § 580b(a)) No deficiency judgment is allowed when the type of loan is either (a) purchase money for an owner-occupied residential one-to-four unit dwelling (“owner-occupied purchase money”) or (b) seller financing (“seller carry-back”).
Deficiency Judgments on Junior Liens (Second Mortgages and HELOCs)
When a first mortgage forecloses on a property, any junior liens attached to the property are also wiped out and the loan(s) become unsecured debts as they no longer have security interest in the said property. In some cases, the “sold out junior loan” may seek restitution or sue the borrower personally on the promissory note. However, as with senior lienholders, California laws provide protections for borrowers which prohibit future judgments on purchase-money loans.
Deficiency Laws After Short Sale and Deed in Lieu
Short Sale: A short sale occurs when a homeowner sells their property for less than the outstanding balance of all liens attached to the property. The laws governing short sales in California (CCP § 580e) prohibit lenders from seeking the deficiency after the short sale on a residential 1-4 unit property, including junior lienholders who agree to the sale.
(CCP § 580e) No deficiency shall be owed or collected, and no deficiency judgment shall be requested or rendered for any deficiency upon a note secured solely by a deed of trust or mortgage for a dwelling of not more than four units, in any case in which the trustor or mortgagor sells the dwelling for a sale price less than the remaining amount of the indebtedness outstanding at the time of sale, in accordance with the written consent of the holder of the deed of trust or mortgage, provided that both of the following have occurred:
(A) Title has been voluntarily transferred to a buyer by grant deed or by other document of conveyance that has been recorded in the county where all or part of the real property is located.
(B) The proceeds of the sale have been tendered to the mortgagee, beneficiary, or the agent of the mortgagee or beneficiary, in accordance with the parties’ agreement.
Deed in Lieu: A deed in lieu often occurs when a borrower is unsuccessful selling their property through a short sale. Most lenders require the borrower to place the home on the market for a minimum of 90 days and if no offers are made, the homeowner may elect to voluntarily transfer (deed in lieu) ownership back to the bank. There are no laws that specifically govern deed in lieus, therefore it’s crucial that there’s verbiage in the agreement that states the lender is “waiving their rights to the deficiency.”