BILL ANALYSIS                                                                                                                                                                                                    






                             SENATE JUDICIARY COMMITTEE
                           Senator Ellen M. Corbett, Chair
                              2009-2010 Regular Session


          SB 931 (Ducheny)
          As Amended March 25, 2010
          Hearing Date: May 4, 2010
          Fiscal: No
          Urgency: No
          BCP:jd
                    

                                        SUBJECT
                                           
                           Mortgages: Deficiency Judgments

                                      DESCRIPTION  

          This bill would prohibit a lender from receiving a judgment for  
          deficiency after a short sale on first mortgages or deeds of  
          trust, as specified.

                                      BACKGROUND  

          California, as well as the nation, is facing an unprecedented  
          threat to the economy and housing market due to the high number  
          of foreclosures occurring throughout the state.  While the  
          initial increase in foreclosures was confined to borrowers with  
          risky sub-prime mortgages, the subsequent economic downturn has  
          spread defaults and foreclosures to all types of loans and  
          borrowers.  Those defaults and foreclosures have many causes,  
          including loss of employment, decreased income due to furloughs,  
          and increases in payment amounts for certain types of mortgages.

          Some borrowers who are unable to make their loan payments and  
          unable to get an affordable loan modification may attempt to  
          sell their home as an alternative to going through foreclosure.   
          As a result of significant declines in housing values, borrowers  
          who owe more on their home than their house is worth must  
          attempt a "short sale" if they want to sell their home. (A short  
          sale is a real estate transaction in which a lender permits a  
          borrower to sell their home for less than is owed on the  
          mortgage.)  While the lender receives less than the full value  
          of the loan in a short sale, the lender avoids the costs of both  
          the foreclosure and resulting expenses if the property ends up  
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          becoming bank-owned after foreclosure.

          Short sales are becoming increasingly popular - up from a few  
          thousand in 2008 to approximately 90,000 in California in 2009.   
          Although borrowers may be under the impression that after a  
          short sale there is no additional liability for the unpaid  
          balance of their loan, some lenders are now requiring borrowers  
          to agree that the lender can pursue them for the difference  
          between the sale price of their home and the unpaid balance.  

          In response to concerns about this practice and that borrowers  
          may have greater liability after a short sale than after a  
          foreclosure, this bill would prohibit a lender from receiving a  
          judgment for deficiency after a short sale on first mortgages or  
          deeds of trust.

                                CHANGES TO EXISTING LAW
           
           Existing law  prohibits a deficiency judgment after a sale of  
          real property under a purchase money mortgage or deed of trust  
          that secures a residential dwelling of not more than four units.  
          (Code Civ. Proc. Sec. 580b.)

           Existing law  prohibits a deficiency judgment on a note secured  
          by a deed of trust or mortgage in any case in which the property  
          has been sold by the mortgagee or trustee  (lender) under a  
          power of sale contained in the mortgage or deed of trust. (Code  
          of Civ. Proc. Sec. 580d.)

           This bill  would prohibit a judgment for any deficiency under a  
          note secured by a first mortgage or deed of trust in any case  
          where the trustor or mortgagor (borrower) sells the dwelling for  
          less than the remaining amount of indebtedness due at the time  
          of sale.  The bill would apply the prohibition only if the sale  
          is with the written consent of the holder of the first deed of  
          trust or first mortgage.

           This bill  would state that the consent of the holder of the  
          first deed of trust or first mortgage to that sale obligates  
          that holder to accept the sale proceeds as full payment and to  
          fully discharge the remaining amount of indebtedness.

           This bill  would further provide that if the trustor or mortgagor  
          commits either fraud with respect to the sale of, or waste with  
          respect to, the real property that secures the first mortgage or  
          deed of trust, the above prohibition shall not limit the ability  
                                                                      



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          of the holder of the first deed of trust or mortgage to seek  
          damages and use existing rights and remedies, as specified.

                                        COMMENT
           
          1.   Stated need for the bill  

          According to the author:

            The purpose of this proposed legislation is primarily to  
            protect distressed homeowners who have non-purchase money  
            recourse loans on residential property (1-4 units), when the  
            fair market value of the subject property is less than the  
            balance of the first deed of trust.  The legislation will  
            make sure that these homeowners do not incur a higher dollar  
            amount of liability after a short sale than they would  
            otherwise have after a foreclosure sale.  For many  
            homeowners in the group described above, a short sale would  
            result in greater personal liability.

          2.    Equalizing anti-deficiency protection in short sales and  
          foreclosures  

          Under existing law, borrowers who lose their home in foreclosure  
          receive "anti-deficiency" protection under several different  
          statutes.  Those statutes generally prevent a judgment for the  
          deficiency on the note that has been foreclosed upon, and for  
          purchase money (nonrecourse) loans that have not been  
          refinanced.  (See Code Civ. Proc. Sec. 580b, 580d.)  As a result  
          of those statutes, borrowers whose homes are sold in foreclosure  
          arguably receive greater protection from deficiency judgments  
          than if they were to proceed with a short sale - most notably,  
          Code of Civil Procedure (CCP) Section 580d precludes a  
          deficiency judgment on the foreclosed loan (generally the first  
          mortgage or deed of trust).  Since there is no equivalent of  
          Section 580d that is specific to short sales, the author asserts  
          that some borrowers have a logical, financially sound reason to  
          opt for foreclosure over short sale, and asserts that the bill  
          would address that issue by ensuring that borrowers do not have  
          a higher amount of liability after a short sale than a  
          foreclosure sale.

          Specifically, this bill would prohibit judgments for deficiency  
          in the context of a short sale, provided that certain conditions  
          are met.  That prohibition would be limited to first mortgages  
          or deeds of trusts (thus excluding, second mortgages, HELOCs  
                                                                      



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          (Home Equity Lines of Credit), etc.), and only apply to  
          residential real property with one to four dwelling units.   
          Considering that lenders generally foreclose on the first  
          mortgage or deed of trust (for which CCP Sec. 580d would  
          prohibit a deficiency judgment in the case of a nonjudicial  
          foreclosure), the prohibition generally equalizes  
          anti-deficiency protection between short sales and foreclosures.  
           From the public policy standpoint, the removal of disincentives  
          for short sales serves to reduce foreclosures and promote home  
          ownership.

          It should be noted that the anti-deficiency protection proposed  
          by this bill is conditioned upon written consent of the holder  
          of the first deed of trust or mortgage to the sale.  Once that  
          consent is given, the holder is obligated to accept sale  
          proceeds as full payment and to fully discharge the remaining  
          amount of indebtedness on that deed of trust or mortgage.   
          Supporters further note that while short sale will appear as  
          "settled debt" on the borrower's credit report, which may hurt  
          their credit rating, the short sale "helps the homeowner feel  
          like they took responsibility for the obligation to pay the  
          money back, rather than just walking away."  Committee staff  
          notes that a foreclosure generally has a much greater negative  
          impact on a borrower's credit score than a short sale.



          3.   Effect of limiting the bill to first mortgages or deeds of  
          trust  

          Since many borrowers do have a first and a second mortgage (and  
          potentially a HELOC) - the limitation of the bill's  
          anti-deficiency protection to first mortgages or deeds of trust  
          would not relieve all borrowers of all future liability after  
          short sale.  If not precluded by the short sale contract or  
          other existing anti-deficiency statutes, those other lenders may  
          be able to pursue the borrower for any deficiency that may exist  
          with regards to their additional loans.  Despite that potential  
          liability, which may come as a surprise to an unsavvy borrower,  
          the bill does serve the goal of ensuring that borrowers are no  
          worse off when choosing a short sale over foreclosure.  From a  
          public policy standpoint, it is favorable to have a home sold to  
          a new owner who will upkeep the property as opposed to  
          potentially reverting back to the lender at a foreclosure sale.

          4.   Exemption for waste or fraud
                                                                      



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           The bill would also provide that if the borrower commits fraud  
          with respect to the sale of, or waste with respect to the real  
          property itself, the new deficiency protection shall not limit  
          the ability of the lender to seek damages and use existing  
          rights and remedies against the borrower or any third party.   
          The author asserts that this provision seeks to preserve an  
          existing exemption under case law for fraud or waste - the  
          provision was inserted after concerns arose that this bill would  
          remove that exemption.
           
           5.   Bill consistent with federal actions

           The author further notes that this bill is consistent with the  
          new federal Home Affordable Foreclosure Alternatives (HAFA)  
          program.  That program, which became effective on April 5, 2010,  
          seeks to provide financial incentives to servicers and borrowers  
          who utilize a short sale or a deed-in-lieu to avoid a  
          foreclosure on an eligible loan.  Similar to this bill, in a  
          HAFA short sale, the lender must forfeit the ability to pursue a  
          deficiency judgment against the borrower.  Although many large  
          servicers may participate in HAFA, committee staff notes that it  
          is a voluntary program.

          6.   Additional supporting arguments  

          Supporters further contend that this bill would prevent further  
          litigation against real estate professionals (who may not be  
          aware of the potential risks of a short sale), encourage short  
          sales which serves the public policy goal of keeping the real  
          estate market moving, and diminish the potential for long term  
          collections and lawsuits. 


           Support  :  Two individuals

           Opposition  :  None Known


                                        HISTORY
           
           Source  :  Author

           Related Pending Legislation  :  SB 1178 (Corbett), would give  
          certain refinanced loans nonrecourse status.  This bill is on  
          the Senate Floor.
                                                                      



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           Prior Legislation  :  None Known

           Prior Vote  :  Senate Banking, Finance and Insurance Committee  
          (Ayes 11, Noes 0)

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