Last year I posted on the subject of deficiency judgments in California. I’m not going to repost the same lengthy and technical post on the subject, but because I keep seeing this problem and questions about it all over the web, I thought I’d chime in one more time.

A deficiency is what is left on the debt after a lender forecloses.  Simple example: House worth $250k, debt of $450k, there’s going to be a deficiency of $200k.  It can be principal and interest on the specific loan that was actually foreclosed, or it can be a completely different loan, like a second or third deed of trust.  California is highly unusual and is very pro debtor in this regard.  More often then not, deficiencies are barred due to the generous anti-deficiency rules.

Here are those rules in a nutshell:

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.

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 the blank one below.  I think you’ll agree that this is pretty clear.

3.   Most deficiency risk that remains after the weeding out of the two above rules can be discharged in bankruptcy.

Together, Rules one and two take care of about 80 percent of the deficiency concerns in California. These days, Rule 3 covers a large chunk of what’s left.

26 Responses to Second Mortgages in California: Deficiencies Not Usually an Issue

  1. Great post, I bet a lot of work and research went into this article.

  2. Bert Wuori says:

    Interesting blog you got here but I can’t seem to find the RSS button.

  3. Thank you for your nice comment. RSS button is at very upper right side of the screen along the title bar.

  4. Brooks says:

    Thank you for your clear explanations. Why is it that some of the blogs are now saying that a sold out junior lienholder can sue for breach of contract on the note even if the loan is an original purchase money loan? They seem to be saying that the second becomes unsecured after the first wipes them out so they are free to sue on the note itself. I thought that 580b was designed to protect against that. What is your opinion? If true, is bankruptcy the only way to protect myself? Thanks

  5. Well, obviously I can’t comment on what other blogs are saying if I don’t know exactly what it is they’re saying. If you could point me to a particular blog post, maybe I could help with that. But 580b is the law in California regarding purchase money loans. For a more complete discussion on the various ant-deficiency statutes, you may want to look at this recent post that just went up the other day. As for whether bankruptcy is a good idea, that can only be answered on a case by case basis.

  6. Brooks says:

    Thanks for getting back to me. The best place to see a discussion about breach of contact from a sold out junior is look at march 3 2010. Thanks again.

  7. That post replies to a specific question. The questions doesn’t specify that the original junior lien was actually a “purchase money loan.”

  8. Interesting thoughts on American foreclosure. We’re lucky it’s not that bad over here in the UK. Our shortage of houses supply has always kept things together a bit!

  9. Luigi Fulk says:

    nice article thx

  10. Been reading for a few days now. This was very good and insightful information. BTW, I love your site design as well. I enjoyed reading it and hopefully you will write more soon. Do you have a newsletter? How do I subscribe to the blog itself?

  11. I´ve been reading your blog for awhile and also it never occurred to me to comment. Which is completely ironic, due to the fact I´ve spent a lot of time over the history few months studying what it takes to make people comment on my own website. Immediately after reading a handful of your posts I guess it´s controversial topics that stir people´s emotions to the point exactly where they can´t just ´let it go.´

  12. Chasidy Khansari says:

    My friend referred me to your blog, so I thought I’d read it for myself. Very interesting reading, will be back for more!

  13. I like to visit your blog a couple times a week for new entries. I was wondering if you have any other topics you write about? You’re a very talented writer!

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    I had to refresh the page 2 times to view this page for some reason, however, the information on here was worth the wait. I loved that it is also really easy to read for the eyes.

  15. Lucius Roehrich says:

    Terrific work! This is the type of information that should be shared around the web. Shame on the search engines for not positioning this post higher!

  16. […] foreclosure?, California Mortgage Deficiencies: What is a Purchase Money Security Interest? and Second Mortgages in California: Deficiencies Not Usually an Issue for full treatment of the […]

  17. […] and statutes: When can a mortgage lender in California recover a deficiency after foreclosure? and Second Mortgages in California: Deficiencies Not Usually an Issue), and it is a very important statute for California […]

  18. crush67 says:

    Hi, it is somewhat comforting to hear the words that “There can be no deficiency on a purchase money loan. Ever.”

    I had two loans to purchase a condo in long beach California. I never refinanced or modified any of the original loans. After four and half years, the first loan/bank foreclosed, the second loan/bank got nothing from the foreclosure of the property.

    The second loan wrote to me about a year ago, I wrote back stating I’m protected under 580b. I have not heard back since.

    However, I’m worried that the second loan will attempt to come after me for a breech of contract and attempt to garnish wages etc.

    Am I really protected? do i need to do anything at this point?

    It has been a year and a half since the foreclosure but i’m constantly worried that someone is coming after me, I have no peace of mind; it is not a nice way to live!

    Kindest regards

  19. Private entities (anyone other than a governmental entity) can’t legally just garnish wages. They must first obtain a judgment or other form of court order. That means they have to file–and serve–a Summons and Complaint. If you haven’t been sued, then there is very little chance that any garnishment can occur. Legally that is. What frequently happens though, is that people stop reading their mail when they’re in a dispute with a lender, and sometimes judgments do get entered without people “knowing about it.” In my experience, that usually happens because folks aren’t paying attention. Don’t ignore your mail and any document that says “You Are Being Sued.”

  20. torisf says:

    Hi David,

    I love your blog. It has provided some excellent insight into the mortgage / foreclosure issues I am encountering.

    Here is my situation, which I am hoping you might provide more insight upon (sorry for the long post, but it’s necessary to understand the full situation).

    I have both first and a second mortgages with the same bank, which total $794K. First is $635K second is $159K

    I have been told that the 2nd has been turned over to a collection department. But the “collection department” is simply a separate department with the same bank, not an outside third party.

    Nothing comparable to my property (2060 sf home, 4 br/3full ba, 8000sf lot) has sold for more than $550K, within a one mile radius for the past year. I listed my home as a short sale, and received an offer for 580K. The first accepted the offer, and allotted $8,500.00 to the second. The second, of course said they would take the $8500 from the first, but they also want me to pay the deficiency for the remaining amount of the 2nd. I responded to the 2nd by offering $5000. in addition to the $8500 that the first offered. I told the 2nd to take it, or I would allow the house to go into foreclosure.

    Here are my questions:

    1) If the first forecloses, can the second (same bank as the first) sue me for deficiency? Particularly in light of the “collection department” scenario?

    2) Can the second foreclose before the first? If so, what does that look like?

    Looking forward to your answers. And yes, I will be giving you a call to retain services / advice before I sign ANYTHING.
    Thank you.

  21. For a number of reasons, I can’t give specific legal advice in this context. However, here are some general observations.

    1. The “collections department” routine is a bureaucratic red herring, a bit of schtick intended to intimidate. Sort of like that junk mail you get with fake certified mail stickers printed on the envelope. A bank is a bank is a bank. They could turn it over to the “janitorial department” and it wouldn’t affect your rights one jot or tittle. When they say that they have assigned or sold it to an outside collection goon, however, while that still doesn’t change your rights, it may affect your bargaining leverage. Collection goons buy debt by the pound–pennies on the dollar. Its a numbers game for them. So you can frequently resolve claims for less than you might have otherwise. Again, that’s just a general observation and is not specifically geared to your situation.

    2. I can’t answer the deficiency question. You haven’t provided enough information, and I can’t give that sort of advice in this context.

    3. As to whether the second can foreclose, anyone with a valid lien on your property can foreclose under the right conditions. It doesn’t matter where in the priority pecking order they are. First second, fourth, tenth. Whether they WILL, however, is a different question. As a general matter, anyone that takes a property back in foreclosure takes subject to the indebtedness that is senior to them, i.e., they have to pay the senior debt or they themselves face foreclosure. Whether junior lien holders are willing to take that risk will depend on the economics of the specific situation.

  22. NCCI says:

    David. With regards to 2nd mortgages where the 1st has gone into foreclosure and the consumer is already out of the house, what is the real collection snapshot here and what are areas of concern? Would any of these recourse laws apply?

  23. Hard to say 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, but if the sold out junior was a purchase money loan, then they can’t.

  24. tlease says:

    My second (loan, not line of credit, made for the purchase of the house) is structured so that there is a balloon payment at the end of 15 years. The notice about the balloon payments says, “you will therefore be required to make payment out of other assets that you may own” or refinance. Would that language allow the lender to seek a deficiency?

  25. If California law applies, the nature of the repayment obligation and any cute language that the lender inserts into the Promissory Note won’t affect your anti-deficiency protections. If it could, then any lender could simply insert any language into their forms and end run the statute. It’s sort of like saying that “despite any law to the contrary, if I want to steal from you I can.”

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