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.
Read on to find out when your lender could get a deficiency judgment against you after a California foreclosure, and what happens to a deficiency in a short sale or a deed in lieu of foreclosure.
To get a deficiency judgment after a nonjudicial foreclosure, the lender has to file a lawsuit against the borrower following the foreclosure sale.
In some states that use judicial foreclosure procedures, the lender can get a deficiency judgment as part of the foreclosure lawsuit itself. In other places, the lender has to seek a deficiency judgment by filing a separate lawsuit after the foreclosure.
California foreclosures are typically nonjudicial, but judicial foreclosures are also allowed.
In California, deficiency judgments aren't not 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, depending on the circumstances, you might face a lawsuit from that lender.
Deficiency judgments are generally allowed after judicial foreclosures in California. But the lender can't get one if the loan was:
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:
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 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:
Completing either one of these options constitutes one action.
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)).
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).
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.
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. If you can't afford an attorney, a HUD-approved housing counselor can tell you about foreclosure avoidance options.