In most California residential foreclosures, the foreclosing bank cannot sue the homeowner for a deficiency judgment.
If your California house sells in a foreclosure auction for less than what you owe on your mortgage loan, you may still be required to pay extra money later. This is because California law permits the foreclosing bank to get a deficiency judgment for the difference between the selling price and the total mortgage obligation in certain instances.
Fortunately, most California foreclosurees will not have to pay a deficiency judgment.
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What Is a Foreclosure Deficiency Judgment?
In a foreclosure, the total amount owed by the borrower may surpass the foreclosure selling price. A “deficiency” is the difference between the total debt and the selling price.
In certain areas, the foreclosing bank may pursue a personal judgment against the debtor, known as a “deficit judgment,” to collect the deficiency. In general, if the bank obtains a shortfall judgment against you, the bank may collect the amount, $50,000 in our case, from your other assets or income.
After California Foreclosures, Deficiency Judgments
Foreclosures in California may be either judicial or nonjudicial. Judicial foreclosures are handled via the state court system, while nonjudicial foreclosures are handled by a foreclosure trustee with no court oversight.
The vast majority of house foreclosures in California are nonjudicial.
Deficiency judgments are not permitted after nonjudicial foreclosures.
In California, a foreclosing bank cannot get a deficiency judgment after a nonjudicial foreclosure. 580d of the California Civil Procedure Code).
Because most home foreclosures are nonjudicial, most Californians facing foreclosure are not subject to a deficiency judgment from the foreclosing bank. However, if you have a second mortgage, you may risk a lawsuit from that lender, depending on the circumstances.
After Judicial Foreclosures, Deficiency Judgments
Deficiency judgments are often permitted if the bank decides to seek judicial foreclosure. The bank must submit an application with the court within three months following the foreclosure sale to get the deficiency judgment. The court will next convene a fair value hearing to evaluate the worth of the property. The deficit judgment will be confined to the lessor of the following:
the amount of debt that exceeds the fair worth of the property at the time of the foreclosure sale, or the amount of debt that exceeds the selling price of the property at the foreclosure auction (Cal. Code Civ. Proc. 726(b)).
However, even if the bank utilizes judicial foreclosure, deficiency judgments are not permitted in circumstances when the loan was:
seller-financed 1-4 unit owner-occupied residence (a “purchase money loan”) issued on or after January 1, 2013, save to the extent that additional principal was advanced that was not used to the purchase-money loan. Fees, fees, and associated refinancing expenditures are also not covered by the anti-deficiency guarantee. 580b of the California Civil Procedure Code).
The One-Action Rule in California
California’s one-action rule restricts a bank’s ability to get a deficit judgment even more. Under this provision, the bank may only pursue one kind of action to collect a debt or mortgage. 726(a) of the California Civil Procedure Code. As a result, in order to recover the defaulted loan, the bank may:
Nonjudicial foreclosure (a trustee’s sale), judicial foreclosure, or suit on the promissory note for the remaining amount.
The Security-First Rule of California
While the one-action rule seems to allow the bank the option of suing the borrower personally on the promissory note and foregoing foreclosure, courts have interpreted the rule to entail that the bank must first seek the secured real estate. According to the “security-first rule,” the bank cannot sue on the note as the initial means of collection. 726(a) of the California Civil Procedure Code.
In California, Deficiency Judgments Following Short Sales
A deficiency judgment after the short sale of a residential property with no more than four units is typically prohibited under California law. Junior lienholders are similarly barred from seeking a deficiency judgment if they consent to the short sale and get the agreed-upon funds. 580e of the California Civil Procedure Code). However, if you conduct fraud or waste with regard to the property (damage it), the bank may demand damages from you. Furthermore, the anti-deficiency statute does not apply to borrowers who are corporations, limited liability companies, limited partnerships, or political subdivisions of the state.
Furthermore, under California law, the bank cannot ask the borrower to pay anything other than the profits of the short sale in return for granting written agreement to the sale. As a result, as a condition of the short sale, the bank cannot ask the borrower to sign a promissory note or contribute monies at the closing of escrow. 580e of the California Civil Procedure Code).
In California, Deficiency Judgments Following Deeds in Lieu of Foreclosure
A “deed in lieu of foreclosure” (deed in lieu) occurs when a bank decides to accept a deed to a property rather than foreclose. The deficiency amount in a deed in lieu is the difference between the total debt and the fair market value of the property.
A deed in lieu of payment is often assumed to completely discharge the obligation. However, there is no statute in California that specifies the bank cannot get a deficiency judgment as a result of this kind of transaction. As a result, the bank may attempt to hold you accountable for a shortfall resulting from a deed in lieu.
In order to prevent a deficiency judgment, the agreement you sign must specifically specify that the transaction fully pays the debt. If this clause is not included in the deed in lieu contract, the bank may bring a lawsuit to seek a deficiency judgment. However, if the bank forgives the shortfall, you may face tax implications.
Junior Lienholders and Deficiency Judgments
Previously, if a bank or mortgage firm owned both senior and junior deeds of trust on a property, the holder could not sue to collect the shortfall on the “sold-out” junior debt after nonjudicially foreclosing the senior deed of trust. However, the California Supreme Court’s judgment in Black Sky Capital, LLC v. Cobb may allow banks and other corporations to enforce several liens on the same property.
In a Foreclosure, What Happens to Junior Liens?
Any junior liens, such as second mortgages, home equity loans, and HELOCs, are also repossessed if a senior lienholder forecloses on your house. This indicates that the junior lienholders’ security interest in the property is no longer valid. In this case, the junior lienholders are referred to as “sold-out junior lienholders.”
Simon v. Superior Court: Over Two Decades of California Law
For more than two decades, California courts have adhered to the ruling of the First District Court of Appeal in Simon v. Superior Court, 4 Cal.App.4th 63. (1992). In that instance, the court ruled that if the same organization (such as a mortgage company or bank) owns both a senior and junior loan on a property, the business cannot seek a deficiency judgment on the junior loan after foreclosing on the senior.
The Fourth District Court of Appeal Comes to a Differing Decision
However, in June 2017, the Fourth District Court of Appeal overturned the Simon verdict. The Fourth District Court of Appeal ruled that California law (specifically, California Code of Civil Procedure 580d) does not preclude a sold-out junior lienholder from suing the borrower for the deficiency following the nonjudicial foreclosure of the first lien—even when the same entity holds both the senior and junior liens (Black Sky Capital, LLC v. Cobb, 12 Cal.App.5th 887 (2017)).
The California Supreme Court consented to hear the case because the Courts of Appeal in the First and Fourth Districts construed Section 580d differently.
The Decision of the California Supreme Court
The California Supreme Court upheld the Fourth District Court of Appeal’s decision. On May 6, 2019, the Court published its decision, determining that where a bank or mortgage business has two deeds of trust on the same property, the holder may seek a deficiency judgment on the junior lien that has been extinguished.
While this ruling broadens lienholder deficiency rights in California, bear in mind that even if you have two deeds of trust on your house owned by the same corporation, another anti-deficiency rule may apply, prohibiting the bank from suing you for a deficiency judgment on the junior lien.
In the Black Sky case, the senior and junior loans were also separated by a significant time interval. “Where there is evidence of gamesmanship by the holder of senior and junior liens on the same property, a considerable dispute would emerge whether the two liens held by the same creditor should…be considered as a single claim,” the court noted. In such cases, Section 580d’s anti-deficiency provision may apply. So, if a lender made both loans simultaneously, basically treating one loan as two (possibly to recoup what it couldn’t recover under the junior loan if it had given a single loan on the same property), the result of such a case may be different.