Beginning on January 1, 2011, in California, if you were approved for a short sale, the first lien holder must automatically waive its deficiency claim that most likely would have resulted from the sale of the property for less than what was owed on the original loan.  This is thanks to the passage of Senate Bill 931 (SB 931) which was passed in September of 2010.

Prior to the passage of the aforementioned bill, most experienced agents handling short sales, spent all their energy trying to accomplish two very important goals: 1)  to get the lenders to release the note with a short pay off of the “mortgage” or sell the house for less than what is owed; and 2)  and more importantly, to get the lenders to waive any resulting deficiency claim arising from the short payoff  of said note.

Most sellers, and even some realtors, did not understand the significance of getting the second component waived in writing and had ridiculous situations where the sellers were approved for and completed the short sale, but ended up still owing the lenders the full amount of the deficiency after having sold the house.  Essentially, they would have sold the house and gained absolutely no benefit.

Imagine this scenario.   The sellers borrowed $500,000 to buy the house.  They were approved to complete a short sale for $300,000, but because the deficiency claim wasn’t negotiated away, the sellers end up still owing the lenders $200,000 (the amount of the short payoff) for their deficiency claim.   Imagine the surprise the sellers faced when the lenders contacted them demanding payments of $200,000 they lost on the transaction.   Trust me, this happened more often than people would like to believe.

Now all we have to do now is negotiate away the deficiency claims for second lenders.

As I am not permitted to give any legal advice, I wanted to share a thorough article written by a brilliant lawyer and a blogger by the name of Ron Ballard, who writes a blog called  California Short Sale Lawyer.  He goes into detail about SB 931, its origin and impact.  It was quite fascinating reading and I wanted to share it.

California Short Sale Anti-deficiency Law – Will Other States Follow

Posted by Ron Ballard

What starts in California often spreads east across the country. Will that be the case for California’s new short sale anti-deficiency law?

On August 19, 2010, the California Legislature approved Senate Bill 931 (SB 931) which added Section 580e to the Code of Civil Procedure (CCP §580e). It expands existing anti-deficiency laws regarding loans secured by dwellings of one to four units to short sales, but only to the first lien holder. It was not passed as “urgency legislation” or with a delayed effectiveness, so it will take effect on January 1, 2011.

In part, the new law provides that: “No judgment shall be rendered for any deficiency under a note secured by a first deed of trust or first mortgage for a dwelling of not more than four units, in any case in which the trustor or mortgagor sells the dwelling for less than the remaining amount of the indebtedness due at the time of sale with the written consent of the holder of the first deed of trust or first mortgage.”

Existing Law

This complements two other anti-deficiency or nonrecourse provisions of CCP §580.

Under CCP §580b, California law provides that “no deficiency judgment shall lie in any event” after a sale of dwelling for not more than four families in connection with 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.” Californians loosely refer to this as saying that a purchase money loan for a personal residence is nonrecourse. It applies to purchase money junior liens as well.

Under CCP §580d, California law provides that “no judgment shall be rendered for any deficiency” upon a note secured by real property “in any case” in which the property has been sold “under power of sale contained in the mortgage or deed of trust.” This generally is referred to as California’s anti-deficiency statute. Notice that it is not limited to dwelling units for not more than four families. This applies to all private, non-judicial foreclosures. It is rare to see a judicial foreclosure in California for residential property. Judicial foreclosures are used almost exclusively for commercial properties.

New Law

The new law follows the verbiage of §580d that “no judgment shall be rendered for any deficiency.” The full verbiage of the new law is provided at the end of this article. It contains several important limitations:

1.  It applies only to the first mortgage or deed of trust.

2.  It applies only to dwellings up to four units, but does not need to be owner-occupied nor purchase money.

3.  It does NOT apply “if the trustor or mortgagor” commits either fraud with respect to the sale of, or waste with respect to, the real property. In these cases, “the holder of the deed of trust or mortgage” may still “seek damages and use existing rights and remedies against the trustor or mortgagor or any third party for fraud or waste.”

4.  It also does not apply “if the trustor or mortgagor is a corporation or political subdivision of the state.” (I will only discuss private borrowers.)

Practical Effects

The most important difference in the new law is that it expands anti-deficiency law from purchase money loans to short sales involving all first trust deed loans. Previously, a homeowner with a cash-out refinance would be subject to potential deficiency liability on a short sale unless the short sale processor was effective enough to obtain a statement in the short payoff approval letter that the payoff constitutes a full discharge of the indebtedness.

The Obama Administration’s “Home Affordable Foreclosure Alternatives” (HAFA) program has a similar provision. However, HAFA comes with many other unattractive and undesirable features. This author’s brief review of articles by real estate agents and brokers indicate that HAFA has not caught on to any great degree. Hence, California’s new law provides a key benefit without the drawbacks of HAFA.

A short term effect may be that homeowners try to delay short sales until 2011. Alternately, short sale processors can use the law to argue for release of liability before 2011 when a foreclosure sale cannot occur in 2010 because it has not been commenced or proceeded far enough.

The law has no effect on a cash-out second loans or HELOC’s. (Some HELOC loans were creatively used as purchase money. Although they typically state they are recourse loans, it is this author’s opinion that they fall within the nonrecourse provisions of CCP §580b because they were used “in fact” for the purchase of the property.)

The law does not apply when there was fraud “with respect to the sale.” The most common cases likely occur when the borrower claims a false hardship or otherwise lies about their financial conditions. This is sometimes referred to improperly as a “strategic default.” A strategic default, or more accurately an intentional default, is done with disclosure that it is a financial decision to breach the loan terms, not as a result of hardship. When a hardship is misrepresented to the lender and the lender justifiably relies upon that misrepresentation, then fraud ordinarily occurred.

The new law also does not apply when the trustor commits waste with respect to the property. Too often short sale properties are “trashed.” The owners neglect maintenance and might remove appliances, etc., or even commit intentional damage. In those cases, the “holder” of the deed of trust can “seek damages.” However, that appears to be limited to damages for waste because it doesn’t say that the deficiency risk remains in effect.

For the full article, click here.

C.A.R. issues consumer alert on refinanced mortgages
C.A.R. issued a consumer alert yesterday warning borrowers of the liability associated with refinanced mortgages.  To help protect consumers, C.A.R. is sponsoring Senate Bill 1178 by State Sen. Ellen Corbett (D-San Leandro) to extend anti-deficiency protections to homeowners who have refinanced “purchase money” loans and now are facing foreclosure. The Senate may vote on the bill as early as next week.

Currently, if a homeowner defaults on a mortgage used to purchase their home, the homeowner’s liability on the mortgage is limited to the property itself.  While this law has helped protect borrowers since its inception in the 1930s, it does not extend the protection for purchase money mortgages to loans that refinance the original purchase debt—even in cases where the loan was refinanced to achieve a lower interest rate.

The above is an alert issued by C.A.R.  (California Association of Realtors)

Most of the clients who come to me to discuss short sales  do a lot of research online and come with the knowledge that California is a Non-Recourse State.  This means the lenders cannot come after the homeowners beyond the property itself (for any deficiency)  if the original intent  the mortgage was to purchase the property, as mentioned above.

What most borrowers  do not realize is that the moment they re-finance to take advantage of lower interest rates, the intent of the money changes to their detriment. Whether the borrower took advantage of a lower interest rate, or cashed out to pay down credit card bills, or to use as down payment on a second property, or to start a business, the nature of the money changes and the protection disappears.   Most loan brokers who were pushing re-finances during the past few years did not inform their clients of the elimination of  this important legal protection.  To be fair, most loan brokers or real estates agents probably were not even aware of such consequences.   But the fact remains,  that for many borrowers, if they were aware of such protection disappearing, perhaps they would not have been so quick to refinance.

SB 1178 is designed to extend that protection once again.   This truly is something that all of us consumers must rally behind, it is simply the right thing to do.   A homeowner should not lose this important legal protection because they want the opportunity at qualifying for lower monthly payments when times are tough.   But guess who is fighting against this measure: the Banks and their lobbyists.

Contact your local State Senator and make sure your voice is heard.   Take back your legal protection.

Sometimes it breaks my heart to hear stories about homeowners who are so mis-informed about this whole foreclosure phenomenon, they simply give up and decide they will let the banks foreclose on them without even exploring the possibility of alternative solutions like a short sale. With all of the discussions of foreclosures and short sales and loan modification and the little known dual track foreclosure, etc….. in the news media, it shocks me that so many homeowners believe that if they were turned down for a loan modification, their only other alternative is a foreclosure.   Not realizing, banks don’t want to foreclose either.

These home owners are so emotionally drained and have beaten themselves up so much about being in their current situation, they almost seem to want to punish themselves.

I had such a meeting with clients yesterday.  This lovely couple was so emotionally drained, they simply resigned themselves to the notion that foreclosure was the only avenue available to them.  They were not even going to explore short sale as an option.  The wife had heard of me through mutual friends and decided to call me just to get some facts to see if there were less invasive methods available to their family.  I explained to them that unemployment  and negative monthly expenditure are viable causes for hardship and the fact their loans were still original purchase money made them ideal candidates for a short sale.   Besides, they had a nice home, which would not be too difficult to sell.

We would try to lessen the impact on their credit and give them a chance to qualify for a Fannie Mae loan in 2 years;   and more importantly, give them a better chance in future employment by not having FORECLOSURE  show up on their credit reports and possibly get them disqualified as candidates for employment since more and more employers are now doing credit checks as a part of  background checks.

After hearing my plan for their home and how to deal with the lenders, I could see the stress leave and smiles appear on their faces.   They thanked me repeatedly for stopping them from falling into the foreclosure trap and giving them a chance at a better method and for returning dignity back to them.

A day like yesterday is a perfect day for me, because I know I am helping people and making a difference in their lives.

Foreclosure is not a viable option. There are better ways both for the borrowers and the lenders.