California Laws on Deficiency Judgments

If you lose your home to foreclosure in California, your liability for the mortgage debt will probably end when the lender sells your property to a new owner at a foreclosure sale. In some limited circumstances, though, if the property sells for less than you owe the lender, you just might get stuck with a hefty bill in the form of a deficiency judgment.

A "deficiency judgment" is a money judgment for the difference between the foreclosure sale price and the total mortgage debt. The deficiency judgment allows the lender to collect the debt through regular collection methods, like garnishing wages or levying a bank account.

Again, though, most people in California won't face a deficiency judgment after a foreclosure sale.

Deficiency Judgments After Foreclosures in California

California foreclosures are typically nonjudicial, but judicial foreclosures are also allowed.

Deficiency Judgments After Nonjudicial Foreclosures in California

In California, deficiency judgments aren't allowed following nonjudicial foreclosures. (Cal. Code Civ. Proc. § 580d).

Because almost all residential foreclosures in California are nonjudicial, most borrowers won't face a deficiency judgment after the foreclosure. But if you have a second mortgage, you might face a lawsuit from that lender depending on the circumstances.

Deficiency Judgments and Judicial Foreclosures in California

Deficiency judgments are generally allowed in judicial foreclosures in California. But the lender can't get one if the loan was:

• used to buy a dwelling that consists of one to four units that's owner-occupied (called a "purchase money" loan)
• financed by the seller, or
• a refinanced purchase money loan that was executed on or after January 1, 2013, except to the extent that new principal was advanced which wasn't applied to the purchase money loan. (Fees, costs, or related expenses of the refinance also aren't covered by the anti-deficiency protection.) (Cal. Code Civ. Proc. § 580b).

Also, even if the lender has the legal right to a deficiency judgment, the amount of the judgment is limited to the lesser of the difference between:

• the total indebtedness and the fair value of the property or
• the total indebtedness and the foreclosure sale price. (Cal. Code Civ. Proc. § 726(b)).

To obtain the deficiency judgment, the lender has to apply to the court within three months of the judicial foreclosure sale and a fair value hearing will be conducted. (Cal. Code Civ. Proc. § 726(b)).

California's One-Action Rule

California's one action rule says that "[t]here can be but one form of action for the recovery of any debt or the enforcement of any right secured by a mortgage upon real property." (Cal. Code Civ. Proc. § 726(a)). So, the lender may choose to:

• pursue a judicial foreclosure and seek a deficiency judgment (if the borrower isn't protected by California's anti-deficiency legislation)
• pursue a nonjudicial foreclosure and forgo a deficiency judgment, or
• sue on the promissory note for the balance of the debt.

Completing either one of these options constitutes one action.

California's Security-First Rule

With such extensive statutory restrictions on deficiency judgments after foreclosure, you might wonder why a lender whose security is severely underwater (where the balance of the mortgage debt outweighs the value of the home) wouldn't simply choose to sue the borrower personally based on the promissory note and skip foreclosing—especially in cases where the borrower has significant assets but has simply chosen to stop paying the debt because the house has become a bad investment.

While the one-action rule seems to give the lender the ability to sue the borrower personally on the promissory note rather than foreclosing, courts have interpreted the rule to mean that a lender must pursue the secured real estate first. Under this "security first" rule, the lender can't sue on the promissory note as the first method of collection. (Cal. Code Civ. Proc. § 726(a)).

Deficiency Judgments After Short Sales in California

In a "short sale", the homeowner sells a property for less than is owed on the mortgage. The lender agrees to accept this "short" amount in exchange for releasing the mortgage lien. Unless the lender agrees to add a provision to the short sale agreement that states the transaction fully satisfies the mortgage debt, the lender generally retains the right to get a deficiency judgment.

But California law prohibits deficiency judgments following short sales of residential properties with no more than four units. Junior lienholders are also prohibited from pursuing a deficiency judgment if they consent to the short sale and received proceeds from the sale as agreed. However, if you perpetrate fraud or commit waste with respect to the property (damage it), the lender can go after you for damages. And this anti-deficiency law doesn't apply to a borrower that is a corporation, LLC, limited partnership, or political subdivision of the state. (Cal. Code Civ. Proc. § 580e).

Also, under California law, the lender can't require the borrower to pay any additional compensation, aside from the proceeds of the short sale, in exchange for giving written consent to the sale. So, the lender can't require the borrower to sign a promissory note or contribute funds at the close of escrow as a condition of the short sale. (Cal. Code Civ. Proc. § 580e).

Deficiency Judgments After Deeds in Lieu of Foreclosure in California

A "deed in lieu of foreclosure" is a transaction in which the homeowner deeds the title to the property directly to the lender. In exchange, the lender agrees to release the mortgage lien. In most instances, a deed in lieu will fully satisfy the debt; but a deficiency could happen with this type of transaction. If the deed in lieu documents clearly state that a deficiency exists and the amount, the borrower remains liable for the deficiency. Generally, the deficiency amount is the difference between the fair market value and the total mortgage debt.

To avoid liability for the deficiency, ask the lender to agree that the transaction completely pays off the debt. Be sure to get this agreement in writing. Without such language in the agreement, you remain at risk that the lender might later attempt to obtain a deficiency judgment against you. Also, it's possible to negotiate a reduced deficiency or pay a lump-sum settlement regarding any remaining debt associated with the transaction. Be aware that you might have tax consequences if the lender forgives all or some of the deficiency.

You might also consider filing for bankruptcy. While bankruptcy might not be a good idea if a deficiency is your only debt, eliminating your liability for a deficiency is an additional benefit if you're already considering it.

When to Seek Counsel

If you're a California homeowner who's behind in mortgage payments and want to learn whether the lender is likely to seek a deficiency judgment, if you have any defenses to a foreclosure, or need information about different ways to avoid a foreclosure, consider talking to a lawyer.

A HUD-approved housing counselor can tell you about foreclosure avoidance options if you can't afford an attorney.