If you owe $800,000 on a $550,000 house and you give the bank the $550,000 house, can the bank try to collect the $250,000 difference? Or to use legal terminology, can the bank seek a deficiency judgment?
The answer, in California, is probably no. California Code of Civil Procedure ยง580b states:
In no case shall a judgment of deficiency be entered after the sale of real estate or years of equity therein due to the buyer’s failure to complete his or her sales contract, or by virtue of a deed of trust or mortgage granted to the seller. to guarantee payment of the balance of the purchase price of that real estate or estate for years, or pursuant to a deed of trust or mortgage on a dwelling for not more than four families made to a lender to guarantee the payment of a loan that was in fact used to pay all or part of the purchase price of that home occupied, in whole or in part, by the buyer.
In plain English, this means that California is for most homeowners a no-recourse state when it comes to “purchase money mortgages.” These are mortgages, including in some cases second mortgages, that were taken out to purchase a home that the buyer actually lived in.
California Deficiency Laws: Who Is Protected
Therefore, three main groups of California mortgagors are excluded from the protection of California’s CPC 580b homeowner:
(1) Investors who bought houses to flip them without intending to live or rent in them
(2) investors buying a property as a rental
(3) homeowners who take on additional mortgage debt after purchasing their home.
California also has a second law that protects mortgagors from its banks: CCP 580d. This law covers all housing debt, including HELOCs, home improvement loans, and second mortgages, but the law only applies to non-judicial foreclosures. These creditors can still collect the remaining debt in a judicial foreclosure.
Impairment Laws in Practice: An Example
Here’s a scenario showing how 580b and 580d work together:
Bob bought a house with $0 down and a 500K interest only mortgage. After the value of his house went up, he took out a second mortgage, which he owes 100K on. Now his house is worth 400K and he has a mortgage debt of 600K.
Let’s say Bob defaults and his house is repossessed and sold for 400K. That leaves 200K in unpaid debt. The first lender gets all of the 400K, but cannot get the remaining 100K that Bob owes.
The second lender now has an option. You can eat the entire 100K loss, or you can go the route of a judicial foreclosure. The bank probably won’t do that if Bob has few assets and a lot of debt, but if Bob has a well-paying steady job, the lender might try: $100,000 is a lot of money to lose.
Under these circumstances, Bob’s best strategy is probably to stop paying the first mortgage and continue paying the second. There are many complicated rules and strict time limits associated with a judicial foreclosure. If Bob continues to pay Lender 2 while he defaults on Lender 1 and waits for Lender 1 to foreclose, the chance that Lender 2 will catch on and undertake the complicated foreclosure court process on time is less than if Bob defrauds both lenders at the same time. Also, the amount owed to Lender 2 will decrease as payments continue to be made, so the value of seeking a deficiency judgment will decrease.
It is best to speak to a lawyer first.
For someone considering withdrawing from their mortgage but wanting to protect their income and other assets from their banks, it would be best to seek the help of a California licensed attorney who can advise on a number of issues, such as:
– Can the bank use some other legal means to pass on its loss to the previous owner, for example, under an equitable or tort theory? Assuming the bank tries, do you have a chance of winning?
– Does 580b protect a homeowner who bought a condo as an investment and rented it out for a year, then moved out and then defaulted on the mortgage?
– What are the state and federal income tax consequences of a foreclosure?
Lawyers aren’t cheap, but every mortgage company has its own army of lawyers and personal collections. Would you really want to go solo against them?