California Homeowners’ Protection Against Deficiency Judgments

Homeowners who are worried about foreclosure may wonder what would happen if a foreclosure sale fails to cover all their debts. For example, if a foreclosure sale raises $50,000, but the homeowner owes $60,000, can the lender sue the homeowner for the remaining $10,000? In California, lenders are unlikely to succeed because the Golden State has the nation’s strongest anti-deficiency laws.

Anti-deficiency laws restrict, and in many cases, prohibit, lenders from collecting the remaining balance from the homeowner. Lenders can only obtain the balance through a court order, or deficiency judgments. However, courts are required to apply anti-deficiency laws liberally in order to carry out certain public policies underlying the anti-deficiency laws.

California enacted its anti-deficiency laws to 1) prevent multiplicity of actions, 2) require exhaustion of security before resort to debtor’s unencumbered assets, and 3) prevent unjust creditor acquisition of borrower’s property (Cadlerock Joint Venture v. Lobel). Each anti-deficiency law is designed to carry out these purposes.

One-Action Rule

The first purpose behind California’s anti-deficiency laws, preventing multiplicity of actions, greatly restricts lenders’ ability to collect deficiency balances. This restriction comes from the One-Action rule, which prohibits lenders or loan servicers from collecting deficiency balances unless the lender uses judicial foreclosure (California Code of Civil Procedure 726(a)). Judicial foreclosure is foreclosure through the courts. This rule channels all attempts to collect deficiency balances through the courts by prohibiting lenders from seeking deficiency balances outside of the courthouse.

Court intervention in the foreclosure process cannot be understated. Most lenders foreclose a home without appearing before a judge. If the lender goes to court, it will cost the lender significantly more time and money, which may discourage the lender from foreclosing the property altogether. Even if the lender decides to go to court, the borrower at least has the opportunity to present his or her case before a judge.

The One-Action Rule does carry an exception though. If the “entire value of security has been lost through no fault of the creditor, the creditor may immediately bring a personal action on the debt” despite the one form of action rule” (Bank of America v. Graves). If the property loses all value and the lender has nothing to do with the loss of value, then the lender can seek deficiency without foreclosing the property in court.

However, “no fault of the creditor” can include a few situations outside of fraud. For instance, “the creditor may not unilaterally divest its security interest without the consent of the debtor” (Cadlerock Joint Venture v. Lobel). The lender must notify the borrower if the lender intends to sell or give away parts of its interest in the property or the lender must comply with the One-Action rule.

Even if the lender does find a way around the One-Action rule though, other anti-deficiency laws may still apply.

Security-First Rule    

In some cases, the lender may seek the deficiency balance before foreclosure. The second purpose of California’s anti-deficiency laws is fulfilled by the Security-First rule, which requires the lender to “exhaust his security judicially before he may obtain a monetary deficiency judgment against the debtor (Security Pacific National Bank v. Wozab). The Security-First rule does not prevent the lender from foreclosing or seeking the deficiency balance. Instead, the Security-First rule forces the lender to choose between foreclosure or deficiency.

Unlike the One-Action rule, the Security-First rule is typically triggered by the borrower. The borrower can raise the Security-First rule as an affirmative defense if the lender seeks deficiency first, thereby forcing the lender to go through the foreclosure process before requesting the deficiency balance. On the other hand, even if the borrower fails to invoke Security-First, “he may still invoke it as a sanction against the creditors…[who] has made an election of remedies and waived the security” (Security Pacific National Bank v. Wozab). In other words, the lender may lose the right to foreclose if the borrower does not trigger the Security-First rule immediately and the lender decides to seek deficiency before foreclosure.

Prohibition on Dwellings  

The One-Action rule and Security-First rule are both restrictions on how a lender can obtain a deficiency judgment. The next anti-deficiency law, Section 580, prohibits deficiency judgments against the borrower altogether. Section 580b prohibits deficiency judgments if the judgment is for a loan used to purchase a dwelling with at most four families living in it (California Code of Civil Procedure 580b).

Section 580 is one of the strongest anti-deficiency protections in the nation. Section 580c extends the deficiency protection to any loan or subsequent loan used to refinance the mortgage, regardless of whether it’s the first refinanced loan or the fifth loan. The first version of 580c only protected the value of the original loan in the refinanced loan. The state legislature recently amended 580c so that refinanced loans executed after January 1st 2013 will receive the same anti-deficiency protection as original loans.

Although Section 580 offers borrowers strong protection against deficiency judgments, 580 does not apply in every case. Section 580b does not apply if the requirements are not met: 1) the loans must be taken out for the purposes of paying the mortgage, and 2) the property must be the borrower’s dwelling. Section 580 does not apply in cases where the lender is suing for fraud because borrowers who commit a wrong cannot be rewarded with legal protection (Alliance Mortgage v. Rothwell).

Conclusion

California offers the strongest anti-deficiency laws in the nation to borrowers thanks to its One-Action rule, Security-First rule, and protection of dwellings. Although the laws contain a few corner case exceptions, homeowners who have been foreclosed are assured that lenders will not take the clothes off their backs as well.

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