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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