The DirtLaw Blog

California's Anti-Deficiency Laws - a brief refresher

What is the anti-deficiency statute?  It is California Code of Civil Procedure Section 580(b).

The code states in relevant part:

"No deficiency judgment shall lie in any event after a sale of real property or an estate for years therein for failure of the purchaser to complete his or her contract of sale, or under a deed of trust or mortgage given to the vendor to secure payment of the balance of the purchase price of that real property or estate for years therein, or under a deed of trust or mortgage on a dwelling for
not more than four families given to a lender to secure repayment of 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."

In plain English - the statute addresses 2 types of loans:

1) purchase money loans and

2) seller carryback loans.

Under the statute, seller carryback loans are not entitled to seek a deficiency judgment against the borrower.  However, there is an exception under California's stare decisis (case law) that does permit the seller to recover against the borrower under certain circumstances.

As for the purchase money loans - no deficiency if it is owner-occupied, residential one to four.  What does that exclude? vacation homes, home-equity lines of credit (HELOC), investment properties where the borrower does not reside there, apartment buildings more than 4 units.

These loans are commonly referred to as "non-recourse" loans because lenders on these types of loan know their only recourse is the security (collateral).

DISCLAIMER: THIS IS NOT INTENDED TO BE A PRIMER ON HOW TO AVOID YOUR DEBTS AND LOAN LIABILITY.  CONSULT WITH A BANKRUPTCY SPECIALIST AND TAX ADVISER.  Please do not email or call me for tax advice.  I am not an accountant or tax professional. 

What We Learned about Subprime Lending in 2007

Back in March of 2007, I noted on here at The DirtLaw blog that a domino effect was occurring, with local Californian company Central Pacific Mortgage getting little press.

Well, when Countrywide began imploding, it seems that national papers began to pay attention.

Things We Learned in 2007:

-  the bad underwriting practices of 2005 are coming back to haunt the industry.  Time to revert to tighter underwriting policies.

- when lenders are under water, likely scenarios include

1. the short sale,
2. the deed-in-lieu
3. the judicial foreclosure plus deficience judgment and
4. debtors surrendering collateral in bankruptcy
5. debtors walking away from the property and not bothering to file bankruptcy

All in all, we've had a busy year at the firm, and I expect to see an increase in the number of judicial foreclosure lawsuits and deficiency judgment activity as well as more loan modifications.

Let's see if my other predictions come to pass about legislation trying to:

a) craft stricter penalties for "predatory lending" (only now vaguely defined by the California Finance Code)

b) modify the anti-deficiency statutes to include re-finance and HELOC loans as well as purchase money loans (possibly with a sunset provision)

c) abridge or abolish the availability of the stated-income loan (think this is already happening, so score 1 for the DirtLaw Blog.)

Judicial Foreclosures in California Part I - Code of Civil Procedure Section 580(a)

The Dreaded Deficiency Judgment

Most people are familiar with the non-judicial foreclosure.  This is a private Trustee's Sale that follows the statutory guidelines of California Civil Code Section 2924 et seq.  California is a trust deed state instead of a "mortgage" state so we generally do not use terms like "mortgagor", "mortgagee" etc. and instead the parties are the Trustor (borrower), the Beneficiary (lender) and the Trustee.

When the borrower seeks out a loan, the borrower executes a promissory note and deed of trust.  The deed of trust contains the power of sale.  The borrower give the Trustee the power to sell the borrower's house (the collateral) if the borrower fails to make loan payments to the beneficiaries (bank/lender).

The non-judicial foreclosure is the quickest way for the bank to take the collateral once the borrowers have stopped paying.  For years, the Bay Area experienced soaring house prices and lenders did not need to worry about any deficiency on their loan if the lender had to take a property back at sale.

These days, the house prices are less rosy and lenders are facing a market where the value of the home is LESS than the loan.  That is the dreaded deficiency.

If the borrowers are still working age, or have other assets, lenders may choose to pursue a judicial foreclosure and seek a deficiency judgment.  What does that mean? It means that the bank will file the Complaint in Superior Court and the sale will not be a private remedy.  Instead, the foreclosure would be conducted by a sheriff--a public sale.  After the sale, the difference in the "fair market value" and debt amount will be the deficiency judgment against the borrowers.

Example - Borrower owes $500k.  The house is worth $400k (as determined by the court appointed independent appraiser "referee") at the time of the sheriff's sale.  The actual sale price may be higher or lower than $400k and Court may issue a deficiency judgment for $100k.

This means the bank has taken the house, sold it, evicted the borrower and the borrower has a judgment against them for $100k.  The bank can then enforce that judgment in a number of ways, such as wage garnishment or if the judgment debtors owns other property, levy against it.

Borrowers may have thought they were safe to walk away from their homes that were in foreclosure because they thought that California's anti-deficiency laws protected them.  What is the anti-deficiency statute?  That is California Code of Civil Procedure Section 580(b) and this applies to purchase money loans and purchase money loans on residential 1-4 units owner-occupied.

Guest Blogging

Occasionally, I am asked to write articles of interest for other Real Estate blogs here in Silicon Valley.  Additionally, reporters occasionally phone me for my thoughts on what is happening with sub-prime lending. 

My recent article for the SiliconValleyBroker on (you guessed it) Short Sale purchasing. 

My quotes to the Palo Alto Weekly (she unfortunately confused the term Short Sale with Short Sell during our phone call).

People Just Can't Get Enough of Short Sales

I've had three calls this week about short sales and the burning question has been, "Can the lender come after the borrower for the difference?"

If the loan (Deed of Trust) is a purchase money loan secured by a house that is the borrower's principal residence, the answer is generally, "No."  California's anti-deficiency laws (California Code of Civil Procedure Section 580(b)-(d) protect homeowners by preventing lenders from doing any more than taking back the property.  These anti-deficiency laws were enacted in Dustbowl era to give homeowners a fresh start, without a deficiency judgment hanging over their heads.

However, the code section is fairly specific.  The loan had to be for the purchase of the property.  The borrower has to occupy it as his or her principal residence. 

Vacation home? No luck.

Investment home? No luck.

In both those circumstances, the lender can choose to file a judicial foreclosure (I am doing more of these this year than in years previous) against the borrower.

Here is the more tricky part - refinance loans or home equity lines of credit.  Technically those are not purchase money loans so in theory, a lender could go after the borrower for the difference.  However, I suspect that in response to the present fears about the volatile sub-prime lending market, legislators will be amending California's anti-deficiency statutes to include refinance loans.  That's my prediction for 2008-2009.  You read it here first at the Dirtlaw Blog TM!

Selling When in Foreclosure and the Dreaded Short Sale

With the recent economic trend, many of the two-year adjustable rate mortgages (or as they are colorfully referred to in the press, "exploding ARMs") have converted.  As a result, many homeowners find themselves in the position that they can no longer afford their monthly mortgage payment.

If these borrowers get too far behind with their lender, a Notice of Default is recorded against their home.  Some borrowers attempt to refinance or sell their property.

As a result, we are seeing an increase in the number of short sales.  What is a short sale? That is when the property value is less than the debt against the property. 

We typically see this when there are multiple loans against the property, for example:

1) Purchase Money Loan from Bank - Deed of Trust

2) Private Money 2nd Deed of Trust from Junior Lienholder or

Home Equity Line of Credit (HELOC) lien.

Many Realtors (TM) who recall the early 90's remember that the short sale is a difficult sale to navigate.  Much of the possibility of closing escrow depends on how many junior liens are against the property.

Often times, it is the junior lienholder who has recorded the Notice of Default and is conducting the Trustee's Sale.  The junior has usually discovered that the borrower is not keeping property taxes and insurance current, or has neglected to pay the senior.  Accordingly, the junior lender will advance the funds to bring the loan current and conduct their own foreclosure sale.

The sums advanced accrue interest as well, as allowed by the terms of the Promissory Note and Deed of Trust. 

In the Short Sale situation, it is the junior lienholder who is faced with receiving a short payoff.  Accordingly, they will rarely agree to a short sale if they feel they could either 1) get more at the Trustee's Sale or 2) take it back at Trustee's sale, fix it up and re-sell for more.

How can one increase the odds of a short sale closing?  Make sure the purchaser/offeror gets the escrow going, and circulate an executed copy of the purchase contract subject to lender approval.  Have the escrow officer get the payoff figures ASAP so that the junior can see the estimated closing statement.   

California Foreclosure Laws and Processes - A Short Review

Seems like hardly a day can go by without an article about how foreclosures in California are on the rise.  The San Francisco Chronicle reported yesterday that California had the second-highest foreclosure rate in the nation, with Nevada being the first.

While it sounds intensely alarming - the actual number reported seems fairly small: "There were 624 Bay Area bank repossessions in June, a dramatic increase from 39 the previous June."

Ok, so that means of the thousands of homes in default last year in the 9 counties of the Bay Area, only 39 actually went back to the bank.

The foreclosure process in California is actually many months.  The average scenario begins with Borrowers missing 2 or 3 payments on their loan to Wells Fargo.  So they miss January, February and March.  During that timeframe, assuming the Borrowers still have income, they still have a chance to bring their loan current by entering into a Forbearance arrangement with Wells Fargo. 

What's a Forbearance Agreement? It's when a lender agrees to forbear from going to Trustee's Sale on their loan in exchange for the borrower making catch-up payments.  That means the borrower will try to make something like 1.5x their normal payment until they are caught up.

Why would a bank agree to this? They would far rather have a performing loan, albeit a slow one, that end up owning the house and tying up their cash.

If the Borrowers do not bring their loan current or do not enter into a forbearance arrangement with the bank, then Wells Fargo will record a Notice of Default (NOD).  Under California Civil Code, Section 2924(a)(1)(D)(2), the Notice of Default must provide 3 months before the lender can Notice a Trustee's Sale.

During this three month timeframe, many borrowers will try to re-finance their loan and pull more equity out of their house to cure the arrearages with the first bank.  This is a short term solution, and in a declining or flat market, is most effective the borrowers then immediately sell the house once it is out of default.  This is often when borrowers will turn to private money investors who will charge a higher interest rate.

Once the three months has run, the trustee will then record a Notice of Trustee's sale, which will set a date for the foreclosure sale that is at least 20 days out.  During that timeframe, the trustee will publish for 3 consecutive weeks the Notice of Trustee's Sale.

That means that start to finish, the foreclosure process in California is about 4 months.  Borrowers who are resourceful can find solutions for themselves in that timeframe and so many defaulted loans never go to sale.

Additionally, if the Borrowers try to sell the property while in default, under certain circumstances, the bank will consider a Short Sale, or essentially taking a payoff of their loan for less than they are owed.  That too can avoid the property from ultimately going to foreclosure sale--however, it can come with tax consequences as a debt forgiveness.

California's warning - Are we headed to another Savings & Loan Crisis?

A week ago, Californian papers reported that  Folsom-based Central Pacific Mortgage was shutting down.  Apparently, Central Pacific's 17-year president and chief executive officer, John Courson, was the 2002 and 2003 chairman of the Mortgage Bankers Association, the national trade group for mortgage bankers.  Additionally, he had been appointed by Governor Schwarzenegger to chair the board of the California Housing Finance Agency, the state's affordable housing bank. The post is unpaid and expires in 2009.

This news was distressing, but limited to the California news stations and did not make much of a ripple nationwide.  However, Central Pacific did originate loans in some 20 states, so its business was not limited to California loans alone.  The company is keeping mum but the rumor mill has it that repurchase obligations crippled the company.

However, today, news that New Century Financial Corp is underwater has been flooding the media.  New Century is (was?) a big player in the subprime lending industry, with a nationwide network.  However, it's recent SEC report was troubling, stating it would need about $8.4 billion should it be forced to repurchase all outstanding mortgage loans and that it doesn't have sufficient liquidity to meet its obligations for repurchasing mortgages.

Could it be that Central Pacific Mortgage's meltdown was the indicator for a larger trend?  What is going with repurchase obligations?  Well, in Februarly Freddie Mac, the nation's 2nd largest financer of home mortgages tightened up its policies.  Freddie Mac announced that it would stop buying subprime adjustable-rate mortgages and will require more borrowers to prove they earn the income they write down on their loan applications.   

I believe that more shutdowns will be announced.  However, I do not believe there is any reason to panic yet.  While this trend may remind some of the Savings and Loan crisis of the 80's, the reasons for the S&L crisis were rooted in a more complex FDIC policy and other goverment policies left over from post Depression legislation.

There is one thing in common with today's present subprime shutdown trend and the S&L and Thrift problems--appraiser fraud.

Under George H.W. Bush's cleanup of the S&L crisis (remember the Keating 5?), legislation was passed to address a multitude of issues.  One of those issues was the lack of standards in appraiser reporting.  For those who need a refresher, here is a helpful chronology of the S&L crisis.

Well, the post has gotten a bit longwinded and I haven't even arrived at the fun part - USPAP.  See Part II to come - for a discussion on Uniform Appraisal standards and FIRREA civil and criminal penalties.

California Trust Deed Investing in a Falling Market

Perhaps you made a few private money loans last year--second or even third deeds of trust and you made those loans under the assumption that you were doing so at a Loan to Value Ratio of 80%.

Trust deed investors in the private money market often rely far more on the LTV ratio than the borrower's credit history due to the very nature of the private money.  Usually the borrowers have already been flagged as too great of a credit risk by major banks, have poor FICO scores and are willing to pay higher interest rates to get their loan.  Accordingly, the appraisal value of the borrower's property is the biggest safety net for lenders.

California real estate values have been phenomenal over the last decade and the rising values have protected trust deed investors and lenders from taking back properties and borrowers from facing foreclosure of filing bankruptcy.

However, there is evidence that even in California, the market is cooling in certain regions.  What if your appraisal report was overly rosy in the first place?  This creates certain problems.  If you made a loan of $100k on a property that you thought was worth $1M, and there is a loan to Washington Mutual ahead of you for $700k--you're at 80%LTV.  But what if the appraisal was too high?  Say it was off by 10%, and the property was worth closer to $900k. 

Well, now your investment is on a far more narrow margin.  Perhaps the market softens further and the property is now only worth $850k. 

Now if the borrower stops making payments to the first, you will be facing a situation where you have advance to the senior.  Instead of being into the loan for $100k, you are advancing $20k or more to bring the loan current and must contemplate bringing your own foreclosure proceedings!

Even worse, if you are under water on this loan, you could be facing a deficiency situation.  This means that you may have to consider a Judicial Foreclosure instead of a private Trustee's Sale.  This option is only available assuming you did not make a purchase money loan.  California's anti-deficiency statute prevents lenders from going after a borrower beyond the equity in the property on purchase money loans. 

Judicial foreclosures take far longer, but are the best alternative if you feel that the fair market value of the property has fallen dramatically.   

California Trust Deed and Foreclosure Investing - Do You Know What's On Record? Part III

If you are a potential trust deed investor, or an investor looking at a California property in foreclosure, you will often look at the public record or obtain a preliminary title report.

If a borrower is in financial trouble, it will be common to see items like Mechanic's Liens, Abstracts of Judgment, or medical liens, or garbage liens, tax delinquency or child support judgments from the California Department of Child Support Services.  All of these items require close scrutiny but if you see a Lis Pendens, this is a major red flag.

What is a Lis Pendens?  It's Latin for Thing Pending, and the English equivalent is "Notice of Pendency of Action."  Who can file one? Any claimant as defined by California Code of Civil Procedure Section 405.1, "'Claimant' means a party to an action who asserts a real property claim and records a notice of the pendency of the action."

Most often, a Lis Pendens is filed in conjunction with an action to Quiet Title to the property, or with a mechanic's lien foreclosure action.  It is public notice to would-be purchasers or bidders to look into the related pending Court action. 

Be advised that if you bid at a Trustee's Sale or purchase a pre-foreclosure property that if you wish to sell the real estate later, it is not likely to be insurable by a title company until the Lis Pendens and liens have been cleared.

This will require engaging an attorney to expunge the Lis Pendens and/or remove the liens.  The California Code of Civil Procedure Section 405.30 provides the means for an owner to apply to the Court for an expungement of the lis pendens.  Section 405.37 also provides for reasonable attorneys fees to be awarded to the prevailing party.