Now, first off, I know that the title I’ve chosen for this post is about as unsexy and non-juicy as it can be.  That’s okay.  I can take it.  It’s boring.  I can hear marketing consultants hollering about how I need to make my title more grabby, sticky, etc.  Yawn. What can I say?  Trying to make this stuff fun and exciting is like trying to turn a root canal into a spectator sport.  And besides, if you’re reading this, you didn’t come here to be entertained.  Maybe someday I’ll change the title but for the moment it stays.

So, anyhow, on the subject of deficiencies…

Far and away the most common question I get asked by clients and potential clients is whether they will be liable for what’s called a “deficiency” after they let a property go in foreclosure.   Please note that the discussion below is limited to California law.  If your property is not in California–it doesn’t matter where you are; what matters is where the property is–then the discussion below will not apply to your situation because the laws in each state about foreclosures and deficiencies is unique to each state’s laws.

First, what is a deficiency anyhow?

A deficiency is, simply defined, the difference between what you owe on your loan(s) minus the value of the property at the time of the foreclosure.  Here’s an absurdly over-simplified example: You owe $250,000 on the loan.  At the time of the foreclosure, the property value is $200,000.  If the lender is entitled to a deficiency (and that’s a HUGE “if” in California) then it would be calculated at $50,000 ($250,000 – $200,000 = $50,000)

Lots of people right now are trying to weigh their options about whether they want to let a property go in foreclosure, file bankruptcy, do a “short sale,” try for one of those “deeds in lieu” or even try to work something out with the lender.  (Right!)  What I am seeing quite frequently is that decisions are being made based on completely wrong information about the extent to which they are at risk for

Next, how do you evaluate the risk of being chased for a deficiency by a lender after foreclosure?

Here are the rules in as simple a way as I can articulate them.  Remember:  THESE APPLY ONLY TO LOANS SECURED BY PROPERTY IN CALIFORNIA. If you don’t live in California, then these rules DO NOT apply to you.

1. There can be no deficiency on a purchase money loan. Ever. This means that if the loan was used to purchase the property, then no deficiency is possible. It doesn’t matter if the holder of the first, second or third forecloses. If the loan on which a lender is trying to get a deficiency is a purchase money loan, then no deficiency is possible. There are wrinkles in this: A HELOC can be purchase money. A loan taken out to refi a purchase money loan cannot. If you have multiple loans, then you have to think about the purpose of the loan.  Let’s say you have a purchase money first, and then you later took out a second. The second, because the loan proceeds weren’t used as “purchase money,” that lender is not barred from pursuing a deficiency in a lawsuit.

2. There can be no deficiency if the lender exercises its power of sale and conducts a non-judicial foreclosure by the mechanism of a trustee’s sale. In order to get a deficiency, the lender MUST file a judicial foreclosure action. That means that they have to sue you in Superior Court. Some people seem confused about whether that piece of paper then got in the mail was a lawsuit or something else. It’s hard to miss: It’s a big 8.5? x 11? document called a “Summons,” and it says in unambiguous writing: “Notice to Defendant….You Are Being Sued By Plaintiff.”  See a copy of one on my post “Second Mortgages in California: Deficiencies Not Usually an Issue.”

3 Responses to California Mortgage Deficiencies (Part 1): What’s a Deficiency Anyhow?

  1. […] in order for this hypothetical to be a real problem, the lender would have to file an action for judicial foreclosure, because under the provisions of CCP §580d, no deficiency is available to a lender who forecloses […]

  2. JAKFLY28 says:

    So, since I had a re-fi, I’m on the hook for the balance. Is there no exclusion, such as F.M.V. ?

  3. I can’t answer that with the info you’ve provided. A non-purchase money HELOC in California is usually a recourse obligation, which means that the lender can seek a deficiency.

%d bloggers like this: