For the thousands of homeowners in Arizona who are “underwater” on their mortgages (the balance of their mortgage debt outweighs the value of their home), the threat of a deficiency judgment following foreclosure is a real concern. (A deficiency judgment is an order by a court for the borrower to pay to the lender the deficiency—the amount the foreclosure sale price falls short of the mortgage debt.) Each state has different rules regarding whether or not a deficiency judgment is allowed. In Arizona, state law prevents a lender from seeking a deficiency judgment following a foreclosure under certain limited circumstances.
There are two anti-deficiency statutes in Arizona that preclude deficiency judgments: one for mortgages and one for deeds of trust.
The anti-deficiency statute for mortgages applies to purchase-money mortgages (mortgages taken out for the sole purpose of purchasing the property securing the mortgage) used to purchase a single one- or two-family dwelling on 2.5 acres or less. So if you took out a mortgage to purchase your single-family home on a lot that is less than 2.5 acres, your lender will not be able to sue you for the deficiency after a judicial foreclosure. Ariz. Rev. Stat. Ann. § 33-729. While this statute appears to only apply to mortgages, Arizona courts have interpreted it as also being applicable to purchase-money deeds of trust that are foreclosed judicially.
The anti-deficiency statute for deeds of trust applies to all deeds of trust that are foreclosed nonjudicially (whether or not the deed of trust is purchase money) where the property does not exceed 2.5 acres and is utilized as a single one- or two-family dwelling. Ariz. Rev. Stat. Ann. § 33-814. Note that this means that if you have a deed of trust that is not purchase money, your lender can avoid the restriction in this anti-deficiency statute and pursue a deficiency judgment by foreclosing judicially.
In summary, if all of the following criteria are met, the lender cannot obtain a deficiency judgment as part of a judicial foreclosure:
And, if all of the following criteria are met, the lender cannot obtain a deficiency judgment as part of a nonjudicial foreclosure:
If neither of these anti-deficiency statutes applies, a deficiency judgment may be sought by the lender as part of the judicial foreclosure itself or in a lawsuit filed within 90 days of a nonjudicial foreclosure sale.
Short sales and deeds in lieu of foreclosure. If a debtor completes a short sale or a deed in lieu of foreclosure, he or she may unknowingly face a deficiency judgment. Arizona’s anti-deficiency statutes do not address whether a deficiency judgment is allowed following a deed in lieu of foreclosure or a short sale. Debtors often mistakenly assume that a short sale or deed in lieu of foreclosure will constitute full satisfaction of the debt. However, Arizona’s anti-deficiency statutes contemplate circumstances where there is an actual foreclosure sale. Since a short sale or deed in lieu of foreclosure does not involve a foreclosure sale, the lender could potentially obtain a deficiency judgment following these actions.
Commercial properties. The anti-deficiency protections only apply to properties used by the borrower as a residence, not commercial properties.
Large parcels. If the loan covers a single one- or two-family residence but is situated on more than 2.5 acres, a debtor could be liable for a deficiency judgment.
Second mortgages (non-purchase money). If you took out a non-purchase-money second mortgage or deed of trust, such as a home equity line of credit, your lender may sue you for the balance of the loan. The Arizona Supreme Court has held that the anti-deficiency statutes apply to second mortgages and deeds of trust as well as first mortgages, but only in cases of purchase-money loans.
Waste. Arizona’s anti-deficiency laws do not apply if the court finds that a debtor committed or permitted voluntary waste. “Waste” occurs when the value of the real property is reduced due to unreasonable damage caused by acts or omissions of the debtor. For example, if a debtor punches holes in the walls, sets fire to the property, breaks windows, or allows others to do such things, then the lender may obtain a judgment for the reduction in fair market value as a result of such waste.
With such extensive statutory restrictions on deficiency judgments after a foreclosure, you may wonder why a lender whose security is severely underwater wouldn’t simply choose to sue the debtor personally based on the promissory note and forego foreclosing on the property altogether. In particular, a lender might prefer to obtain a money judgment against a debtor in cases where the debtor has significant assets but has simply chosen to stop making mortgage payments because the house has become a bad investment.
In Baker v. Gardner, 160 Ariz. 98, 770 P.2d 766 (1988), the Arizona Supreme Court held that a lender cannot waive the security and sue on the note to hold the borrower personally liable because it would circumvent the legislature’s intent of protecting homeowners when it enacted the anti-deficiency statutes. The court decided that if the anti-deficiency statutes would apply to the mortgage or deed of trust, the lender cannot bypass a foreclosure to sue directly on the note.
For more detailed statutory information, the laws that govern Arizona mortgage and deed of trust foreclosures are located in Title 33, Chapters 6 and 6.1 of the Arizona Revised Statutes. The law as it applies to each individual situation varies based on the particular circumstances of the case. If you need individualized legal advice, please consult with a licensed attorney.