California Short Sale & Deficiency Balance

UpdatedJul 26, 2010

Key Takeaways:

A short sale is the sale of property for less than the balance of the mortgage.
Review California's intricate short sale rules.
Homeowners in California can sacrifice certain rights when they refinance.

If I let my California home go into foreclosure, can the lender collect any deficiency balance from me?

If I refinanced my owner occupied home and I sell it in a short sale, because this is a recourse loan, the lender can come after me. If I let it go into foreclosure, can the lender still come after me? I reside in California.

Allow me to define a short sale. A short sale is where a mortgagee (most likely a bank) agrees to the sale of a property for less than the balance of the loan. The new owner may not be liable for what is known as the "deficiency balance." Some banks do not forgive the deficiency balance, and others do. See the Bills.com resource How to Short Sale to learn more about short sales. Editor's note: California SB 931, which was signed into law September 30, 2010, outlaws a deficiency judgment under a note secured by a first deed of trust or first mortgage for a short sale. SB 458, passed into law in mid-2011, changed CCP 580e to not allow the collection of deficiency balances for all notes secured by mortgages or deeds of trust in a short sale situation.

Banks that participate in the Home Affordable Foreclosure Alternatives (HAFA) program may not collect a deficiency balance from former owners.

Refinancing a purchase money loan removes the California anti-deficiency protection. However, if you short sale the property and as mentioned above, your bank is not participating in HAFA, it may collect any deficiency balance. See the Bills.com resource California Deficiency Balance and Is My HELOC a Recourse or Non-Recourse Loan in California? to learn more about the nuances of California's anti-deficiency rules.

You mentioned foreclosure. Foreclosure is the legal process through which a lender (most typically a mortgage lender) claims an asset from the consumer borrower who has defaulted on their mortgage payments. Because foreclosure is expensive and usually results in a poor return, lenders do not like foreclosure any more than homeowners do. See the Bills.com resource Mortgage Foreclosure California to learn more about California's rules regarding foreclosure.

You have personal liability for a deficiency balance. This means that even if there is a foreclosure you must pay the difference between the auction price and the balance of the loan.

One final thought. You may face a California state income tax liability for a short sale. See the Franchise Tax Board documents Foreclosure and Short Sale and How Do I Report a Short Sale and Mortgage Forgiveness Debt Relief Extended for discussions of the tax implications.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com

6 Comments

SSleepless, Oct, 2013

HiWe bought a home in central valley (CV) in 2005. Never refinanced the loan. In 2012, we bought another home in East Bay (EB) which we made it our primary home. We rented out the CV home for 1 year and are now considering a strategic default/short sale as that home is still underwater. We have a 525k balance and the home is probably worth about 425k currently. If we short sale or foreclose, is there any recourse from the bank i.e will we be liable for payment of the deficient amount using either method? Secondly, if we prepare to short sell/foreclose, can we stop paying the property taxes or are we still liable for that and should continue paying until the short sale/foreclosure is completed? Secondly, will there be a difference if we short sale or foreclose? We're not much concern about not being able to get a loan or credit card. We're planning to stay in our EB home for the next 15 years and not planning to get any new credit cards or loans. We have about 10 credit cards and are looking to pay them off every month to rebuild our credit post foreclosure/short sale.

BBill, Oct, 2013

California's anti-deficiency laws are tricky. A small change in a homeowner's facts can make a big difference in the answers to your questions. Therefore, your smartest course of action is to consult with a lawyer who has foreclosure or mortgage negotiation experience. What follows is a general observation about the law.

Under California statute and case law, purchase money loan(s) are included in the state's anti-deficiency law in the event of a foreclosure. In other words, as long as a homeowner doesn't refinance, lenders may not pursue the homeowner for a deficiency balance on purchase money loans in the event of a foreclosure. This includes 80/20 loans that are not refinanced.

Under a relatively new addition to California law, lenders cannot pursue a homeowner for a deficiency balance if he or she signs a short sale contract. This law does not exclude refinanced loans.

What does this mean to you? You mentioned you never refinanced the Central Valley home. If so, you can either walk away and allow a foreclosure, or short sell the property, and the lender cannot pursue you for the deficiency balance. My advice? First, talk to a lawyer to make sure my analysis here is correct. Second, ask the lender about a short sale? Why a short sale if the end result is the same, regarding liability for the deficiency balance? Short sales cause slightly less damage to your credit score, and you will qualify for a mortgage refinance sooner if you short sell the property. In other words, a short sale will give you more options sooner if you want to qualify for a new loan.

BBill, Aug, 2010

If the passage you quoted is accurate and your junior was a purchase-money loan, then I do not see liability for you under California law. The passage you quoted has the sentence clause that says to the effect, "but we are not trying to take away any rights you may have." Even if that little sentence clause did not exist I do not think a consumer can contract away his or her anti-deficiency rights in California.

ccat graham, Aug, 2010

Hi,The 2nd mortgage was a purchase money loan. My concern was that if I signed the closing papers the language added by BofA in the short sale approval letter waived my right to CA State law protection for non-recourse loans. If it is a non-recourse loan, are they prohibited from coming after me for the deficiency even if I sign papers that advises me that they reserve the right to pursue me?Thank you so much!

BBill, Aug, 2010

Impossible to answer without knowing more. Was the junior a purchase-money loan? In other words, was the junior used to purchase the property, or did you get this loan after you bought the property. If it is a purchase money loan and you never refinanced it, then it is a non-recourse loan and the language Bank of America added to the contract is meaningless. If, however, you got this loan subsequent to the purchase, or you refinanced, then I see liability for you under California law. Your only option to avoid Bank of America pursuing you (assuming you have liability, as discussed above) is to find a way to convince Bank of America to write opposite language into the contract that prohibits their pursuing the deficiency. As far as your credit report is concerned, it probably makes no difference if you allow the foreclosure and then file for bankruptcy, or allow the short sale and then file. Were it me, I would do the short sale and then cross my fingers that Bank of America would leave me alone, which may still leave bankruptcy as an option later. Consult with a bankruptcy attorney in California and discuss your options and whether you qualify for bankruptcy now (with a foreclosure) or in the future (with a short sale).

ccat, Aug, 2010

I sold my condo in CA on a short sale - the 2nd mortgage holder, BofA, has the following clause in the approval letter - "they may pursue a deficiency judgement for the difference in the payment received and the total balance due, unless agreed otherwise of prohibited by law." I am assuming if I sign the closing papers, I am waiving my right to protection under CA laws on non-recourse loans - are 2nd mortgages even included in that law? BofA WILL NOT remove the clause for less than $65,000 which I do not have and the buyer will not pay.Now my dilemma is whether to let it go to foreclosure or file Chapter 7 now. What is my best option to avoid being pursued for the deficiency on the 2nd mortgage?Thanks so much,Cat