Update: In early April, the Judicial Council of California, which is the policy-making arm of the state’s court system, approved temporary emergency rules putting judicial foreclosure actions and evictions on hold during the coronavirus (COVID-19) crisis. (While the majority of California foreclosures are nonjudicial, lenders sometimes opt to file lawsuits to foreclose with the courts. An eviction action after a nonjudicial foreclosure also has to go through the court system.) On June 10, 2020, the Judicial Council was scheduled to vote on a proposal that would have allowed judicial foreclosure and eviction proceedings to resume in August. But on June 10, 2020, the Council instead delayed making a decision. Also, if you have a specific kind of mortgage loan, you might be entitled to a foreclosure moratorium.
One of the big worries borrowers have after a foreclosure is whether the lender is entitled to a deficiency judgment. If the property sells at a foreclosure sale for less than the borrower's total debt, the difference between the sales price and the total debt is known as the "deficiency." For example, if a homeowner owes $350,000 to the lender and the property sells at the foreclosure sale for only $300,000, the deficiency is $50,000.
In some states, the lender is allowed to sue the homeowner, either in the foreclosure action itself or in a separate suit (depending on state law), for this difference and obtain a "deficiency judgment." A deficiency judgment is a personal court judgment against the borrower. The deficiency judgment allows the lender to collect the debt through regular collection methods, like garnishing the borrower’s wages or levying a bank account.
In California, a deficiency judgment is not allowed following a nonjudicial foreclosure. (Cal. Code Civ. Proc. § 580d). Almost all residential foreclosures are nonjudicial foreclosures in California. (But if you have a second or third mortgage, or a HELOC, in certain circumstances you might face a lawsuit from one of those lenders.)
A deficiency judgment is allowed with a judicial foreclosure; but, a lender may not get a deficiency judgment if:
Furthermore, even if the lender has the legal right to obtain a deficiency judgment, the amount of the judgment is limited to the lesser of:
To obtain the deficiency judgment, the lender must 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 provides in part 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)). This means that the lender may choose to:
Completing either one of these options constitutes one action.
When junior lenders lose their security in the property due to the senior lienholder’s foreclosure, they are still are entitled to their one action. This means a junior lienholder (called a "sold-out," or "wiped-out," junior lienholder) can file a suit on the promissory note, which is unsecured following the foreclosure, to recover the remaining balance from a borrower, so long as the borrower is not protected by the anti-deficiency rules.
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 debtor personally based on the promissory note and forgo foreclosure—especially in cases where the debtor has significant assets but has simply chosen to stop paying the debt because the house has become a bad investment. Lenders can’t sue debtors personally for mortgage debts because California law requires lenders to first foreclose before attempting to sue the borrower personally to collect the debt. This is called the "security-first" rule.
When a home is sold by a short sale, the transaction will not satisfy the total amount that is owed. A short sale occurs when a property is sold for less than is owed on the total mortgage debt. In California, the lender cannot obtain a deficiency judgment following a short sale on a residential property that contains not more than four units. Junior lienholders are also prohibited from pursuing a deficiency judgment if they've agreed to the short sale. (Cal. Code Civ. Proc. § 580e).
A deed in lieu of foreclosure could also result in a deficiency. The deficiency will be the difference between the property’s fair market value and the total debt. If you intend to complete a deed in lieu of foreclosure and want to avoid a deficiency judgment, you should negotiate with your lender to include language in your deed in lieu of foreclosure agreement that the transaction fully satisfies your entire mortgage debt. Without such language in the agreement, there remains a risk that the lender might later attempt to obtain a deficiency judgment against you.
If you’re a California homeowner facing a foreclosure and want to learn whether you might face a deficiency judgment, if you have any defenses to the action, or want to find out about different ways to avoid a foreclosure, consider talking to an lawyer. If you can't afford a lawyer, a HUD-approved housing counselor can tell you about foreclosure avoidance options.