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 (more) SB 1069 (Corbett) Page 2 of ? 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).) SB 1069 (Corbett) Page 3 of ? 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 SB 1069 (Corbett) Page 4 of ? 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 SB 1069 (Corbett) Page 5 of ? 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." SB 1069 (Corbett) Page 6 of ? 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. ************** SB 1069 (Corbett) Page 7 of ?