Any financial institution that grants loans in exchange for a mortgage in real estate knows that a foreclosure is a distinct, and increasing, possibility. Typically, a completed foreclosure will result in a deficiency balance due the lender after the sale of property. In most states, it is possible to proceed against the borrower for collection of that deficiency balance. However, there are an increasing amount of states that do not allow recovery of a foreclosure deficiency balance.
There are currently eleven states that would be classified as “non-recourse”, in that there is a bar on collection of a deficiency balance after foreclosure. These states have differing levels of stringency in the collection of a foreclosure deficiency balance. See Alaska (Alaska Statutes Chapter 09.45); Arizona (Arizona State Code Title 33-814.G and 33-729.A); California (Code Civ. Proc. § 580b); Iowa (Iowa Ch. 654.6); Minnesota (Minnesota Statute 582); Montana (Montana Code Annotated Title 71, Ch. 1); North Carolina (North Carolina General Statutes Ch. 45 Article 2B, §§ 21.36 and 21.38); North Dakota (North Dakota Century Code Ch. 32-19-01); Oregon (Chapter 88); Washington (Revised Code of Washington Title 61, Ch. 61-12); Wisconsin (Wisconsin Statutes and Annotations Ch. 846).
A state with one of the most stringent anti-deficiency laws is California. California CCP § 580b(3) states that no deficiency judgment shall lie under a deed of trust or mortgage on a dwelling for not more than four families given to a lender to secure repayment of a loan which was in fact used to pay all or part of the purchase price of that dwelling, occupied entirely or in part by the purchaser. Simply put, there can be no deficiency judgment after foreclosing on a “purchase-money loan” that was obtained for the purpose of purchasing the property. It does not matter if it’s a first, second, or third mortgage, or whether it was a home equity line of credit. If the borrower obtained the loan and granted a mortgage to the lender to secure all or part of the purchase price, no deficiency is permitted after foreclosure.
Moreover, CCP § 580 was recently amended by the California legislature to include refinances of a purchase-money loan as exempt from deficiency. § 580c states that no deficiency judgment shall lie in any event on any loan, refinance, or other credit transaction which is used to refinance a purchase money loan, or subsequent refinances to a purchase money loan, except to the extent that the lender advances new principal which is not applied to the balance on the purchase money loan. Refinances were generally excluded from the Anti-Deficiency Law prior to the 2012 amendment.
It is also important to note that California employs the “One Action Rule” of CCP § 726(a). This rule provides that a lender is required to proceed against the collateral first, and then proceed against a deficiency balance if possible. In California, deficiency judgments are only permitted after a Judicial Foreclosure, and only if the anti-deficiency statute does not apply.
The clear language of the California statute provides that deficiency is not permitted on purchase money loans. The question remains, is it ever possible to collect on a foreclosure deficiency in California? As stated, CCP § 726(a) does allow a deficiency action so long as it is the result of a judicial foreclosure, and the provisions of CCP § 580 do not apply. As a result, mortgages granted on commercial properties will give rise to a possible deficiency action after foreclosure. Also, investment properties would be excluded as it is not the borrower’s primary dwelling. Apartment buildings would also be excluded if it contained more than four units.
A more difficult issue is whether a second or third mortgage was granted as part of a home equity line of credit, or some other mortgage vehicle. The controlling factor under the California law is whether the mortgage was granted to secure all or part of the purchase price of the dwelling. As such, a deficiency balance resulting from a second mortgage granted to secure a home equity line of credit would not be barred by the California law if it was not part of the purchase price of the home. However, a deficiency balance arising from a second mortgage granted that was used to secure the purchase price, such as an 80/20 loan, would be barred by the California law.
While California maintains a stringent Anti-Deficiency Law, it does not exclude all deficiency claims after foreclosure. There are exceptions for deficiency balances resulting from mortgages that were not “purchase-money” for a primary dwelling. If financial institutions continue to take mortgages on real estate in California, it is important to have a working understanding the California Anti-Deficiency Law to properly safeguard their rights in the collateral.