BILL ANALYSIS                                                                                                                                                                                                    Ó






                             SENATE JUDICIARY COMMITTEE
                             Senator Noreen Evans, Chair
                              2011-2012 Regular Session


          SB 1069 (Corbett)
          As Amended March 15, 2012
          Hearing Date: May 1, 2012
          Fiscal: No
          Urgency: No
          SK:rm
                    

                                        SUBJECT
                                           
                           Mortgages: Deficiency Judgments

                                      DESCRIPTION  

          This bill would prohibit a lender from receiving a deficiency 
          judgment for any loan, refinance, or other credit transaction 
          that is used to refinance a purchase money loan.

          This bill would apply only to credit transactions occurring on 
          or after January 1, 2013, and would not apply to the principal 
          amount of any new advance, as specified. 

                                      BACKGROUND  

          California has several anti-deficiency statutes that seek to 
          protect individuals from a "deficiency judgment" when their home 
          is sold for less than is owed on their loan.  Absent those 
          statutes, a lender who suffers a loss as the result of the sale 
          (in other words, selling the property for less than the balance 
          of the loan) could potentially bring an action seeking recovery 
          of the amount lost, the "deficiency," as the result of the sale. 
           For example, one section bars a lender from seeking a judgment 
          for any deficiency following a non-judicial foreclosure.  That 
          protection is limited to the specific note that was foreclosed 
          upon.  (Code Civ. Proc. Sec. 580d.)  Another section protects 
          borrowers from a deficiency judgment in the case of a short 
          sale.  (Code Civ. Proc. Sec. 580e.)

          This bill, sponsored by the Insolvency Law Committee of the 
          Business Law Section of the State Bar, would amend a related 
          section that provides broad protection from deficiency 
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          judgments.  That section prohibits a deficiency judgment for 
          loans that were used to "pay all or part of the purchase price." 
           (Those loans are often referred to as "purchase money.")  That 
          protection, which applies after sale of the property, is limited 
          to loans securing owner-occupied dwellings of not more than four 
          families.  Staff notes that while many argue that the provision 
          is limited to judicial foreclosures, some legal experts contend 
          that the plain language of the statute allows application beyond 
          that context to other types of sales.  
          Under existing case law, the above deficiency protection is 
          arguably lost when an individual refinances his or her mortgage. 
           In other words, refinancing may cause a loan to change from 
          "non-recourse" - meaning the borrower is not liable for any 
          deficiency - to a "recourse" loan - meaning the borrower may be 
          liable for a deficiency.  To address that issue, this bill would 
          preserve the above anti-deficiency protection when loans are 
          refinanced, except to the extent the lender or creditor advanced 
          new principal.

          This bill is similar to SB 1178 (Corbett, 2010), which was 
          vetoed by Governor Schwarzenegger due to concerns about, among 
          other things, interference with existing contracts.  This bill 
          seeks to address those issues by only applying prospectively to 
          loans executed on or after January 1, 2013. 

                                CHANGES TO EXISTING LAW
           
           Existing federal tax law  generally allows a deduction for all 
          interest paid or accrued within the taxable year on 
          indebtedness.  Existing law limits that deduction for "personal 
          interest" paid or accrued, with the specific exceptions, 
          including any qualified residence interest.  (26 U.S.C. 163.)

           Existing federal tax law  defines qualified residence interest as 
          any interest that is paid or accrued during the taxable year on 
          either:  (1) acquisition indebtedness; or (2) home equity 
          indebtedness.  Acquisition indebtedness is defined as 
          indebtedness that is incurred in acquiring, constructing, or 
          substantially improving a qualified residence of the taxpayer, 
          and that is secured by that residence.  That term also includes 
          any indebtedness secured by such residence resulting from the 
          refinancing of indebtedness, as specified, but only to the 
          extent the amount of the indebtedness resulting from such 
          refinancing does not exceed the amount of the refinanced 
          indebtedness.  (26 U.S.C. 163(h)(3)(B).) 
           
                                                                      



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          Existing law  provides for procedures by which a money judgment 
          (a "deficiency judgment") can be sought for the balance due on 
          an obligation for the payment for which a deed of trust or 
          mortgage was given as security.  A court may render judgment for 
          not more than the amount by which the entire amount of 
          indebtedness due at the time of sale exceeded the fair market 
          value of the real property or interest therein sold at the time 
          of sale, with interest from the date of sale, as specified.  
          (Code Civ. Proc. Sec. 580a.)

           Existing law  prohibits a deficiency judgment after the sale of 
          real property under a deed of trust or mortgage on a dwelling 
          for not more than four families.  That provision applies to 
          loans that were used to pay all or a part of the purchase price 
          of the dwelling that was occupied by the purchaser.  (Code Civ. 
          Proc. Sec. 580b.)

           This bill  would apply the above deficiency judgment prohibition 
          to any loan, refinance, or other credit transaction that is used 
          to refinance a purchase money loan, as defined, except to the 
          extent that the lender or creditor advances new principal, as 
          specified.
           This bill  would provide that any new credit transaction shall be 
          deemed to be a purchase money loan except as to the principal 
          amount of any new advance.  Payment of principal shall be deemed 
          to be applied first to the principal balance of the purchase 
          money loan and then to the principal balance of any new advance; 
          interest payments shall be applied to any interest due and 
          owing.

           This bill  would apply the above provisions only to credit 
          transactions executed on or after January 1, 2013.

                                        COMMENT
           
          1.    Stated need for the bill  

          According to the author:

            Under current state law, lenders may seek a deficiency 
            judgment in a judicial foreclosure for a non-purchase money 
            loan.  Refinanced loans are considered non-purchase.  It is 
            unfair to subject homeowners to new personal liability 
            merely because they refinanced the original mortgage.  
            California has extended protection from deficiency judgments 
            to homeowners in the event of a short sale with the 
                                                                      



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            enactment of Senate Bill 458 (Corbett, 2011) and Senate Bill 
            931 (Ducheny, 2010). The unfairness is particularly acute in 
            that almost no borrowers understood the new liability that 
            was being acquired along with the refinance.

          The author further notes that, "Ýa]ccording to recent news by 
          the Mortgage Bankers Association ÝMBA], applications for 
          refinances continue to steadily increase as homeowners attempt 
          to take Ýadvantage] of lower interest rates. . . .  Data from 
          MBA also notes that the refinanced loans continue to make up a 
          significant, if not majority, of mortgage originations 
          nationwide. Indeed, over two-thirds of mortgage originations 
          derived from refinances, accounting for about $1.7 trillion of 
          total mortgages since 2010."

          2.    Background on the deficiency judgments at issue; codifying 
          protection for refinances  

          Under existing law, when an individual takes out a loan to 
          purchase a home, that loan is protected from a deficiency 
          judgment under Code of Civil Procedure 580b.  Since there can be 
          no deficiency judgment following a "sale" of the property, the 
          loan is considered to be "non-recourse" and the borrower has no 
          personal liability following the sale of the property.  On the 
          other hand, if the borrower subsequently takes out a home equity 
          loan, or another loan that is not used to purchase the property, 
          that loan is considered "recourse" because the borrower could 
          potentially have personal liability following sale.  Despite 
          that distinction, staff notes that there are several deficiency 
          judgment statutes that may provide protection even in cases 
          where a "recourse" loan is subject to foreclosure.

          While the above deficiency judgment protection reflects a desire 
          by the Legislature to limit financial liability for homeowners 
          following the sale of their home, subsequent case law has 
          arguably held that a homeowner who refinances his or her 
          original loan loses their Section 580b protection against 
          deficiency judgments.  Specifically, in Union Bank v. Wendland 
          (1976) 54 Cal.App.3d 393, the Court of Appeal noted that:
           
            Section 580b was drafted to protect purchasers under the 
            standard purchase money mortgage transactions in which the 
            vendor of real property retains an interest in the land sold 
            to secure payment of part of the purchase price ?.  
            "Variations on the standard are subject to section 580b only 
            if they come within the purpose of that section." ?.  The loan 
                                                                      



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            transactions with Ýthe refinancing lender] are variations from 
            the standard that do not come within the purpose of section 
            580b.  Accordingly, when Ýthe homeowner] refinanced the 
            property ? he lost the purchase money protection afforded by 
            section 580b.  (54 Cal.App.3d at 399-400, citations omitted 
            and emphasis added.)

          This bill seeks to respond to that case by clarifying that no 
          deficiency judgment shall lie on any loan, refinance, or other 
          credit transaction which is used to refinance a "purchase money 
          loan," except to the extent the lender advances new principal 
          that is not used to satisfy the purchase money loan, or to fees, 
          costs, or related expenses of the transaction.  

          3.    Application of bill's provisions  

          This bill would generally preserve the non-recourse nature of 
          purchase money loans in the case of a refinance.  As noted by 
          the author, a large number of mortgage originations occur due to 
          refinances and the individuals who refinance their loans are 
          generally unaware that the refinance itself may result in the 
          loss of anti-deficiency protection under Section 580b.  The 
          proposed protection for refinances would:  (1) only apply to 
          those credit transactions occurring on or after January 1, 2013; 
          and (2) not protect any additional money taken out by the 
          homeowner as part of the refinance.

            a.   Amounts owed under original loan plus fees

             The anti-deficiency protection provided by this bill would not 
            apply to any additional funds that are taken out by the 
            borrower as part of the refinance, unless that amount is 
            applied to "fees, costs, or related expenses of the credit 
            transaction."  While that protection ensures that the original 
            loan doesn't change its nature due to the refinance, it may 
            leave homeowners with anti-deficiency liability for moneys 
            taken out for things ranging from vacations to completing 
            necessary repairs on their homes.

            For example, a refinance of a purchase money loan occurring on 
            or after January 1, 2013, where no additional money is taken 
            out, would be fully covered under the provisions of this bill. 
             Alternatively, if a homeowner refinanced the same property 
            but elected to take out additional moneys in order to replace 
            a leaking roof, this bill's anti-deficiency provisions would 
            not protect the "new advance." 
                                                                      



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            b.   Credit transactions on or after January 1, 2013

             The provisions of this bill would only apply to credit 
            transactions occurring on or after January 1, 2013.  While 
            prospective application of SB 1069 would not cover the 
            numerous individuals who refinanced in recent years to either 
            take advantage of lower interest rates or avoid foreclosure, 
            it would appear to respond to concerns raised in Governor 
            Schwarzenegger's veto of SB 1178 by applying retrospectively.  
            The veto message stated:

               ÝSB 1178] fundamentally alters the nature and impairs the 
               value of previously negotiated contracts, leading to 
               negative consequences for the value of those loans held 
               in a lender's portfolio and a deleterious impact on the 
               secondary market.  Fundamentally altering the nature of a 
               contract after its consummation is a bad precedent and 
               will provide uncertainty for future lending transactions.


           Support  :  California Association of Realtors; California Bankers 
          Association; Center for Responsible Lending

           Opposition  :  None Known

                                        HISTORY
          
           Source  :  Insolvency Law Committee of the Business Law Section of 
          the State Bar

           Related Pending Legislation  :  None Known

           Prior Legislation  :  

          SB 1178 (Corbett, 2010) See Background.

          SB 458 (Corbett, Chapter 82, Statutes of 2011) expanded 
          anti-deficiency protection for short sales. 

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