Jingle Mail and California Law: Giving the mortgage back to the bank

If you owe $800,000 on a $550,000 house, and give the bank the $550,000 house, can the bank then try to collect the $250,000 difference? Or to use the legal terminology, can the bank seek a deficiency judgment?

The answer, in California, is probably not. California Code of Civil Procedure §580b states:

No deficiency judgment shall lie in any event after a sale of real property or an estate for years therein for failure of the purchaser to complete his or her contract of sale, or under a deed of trust or mortgage given to the vendor to secure payment of the balance of the purchase price of that real property or estate for years therein, or under a deed of trust or mortgage on a dwelling for not more than four families given to a lender to secure repayment of a loan which was in fact used to pay all or part of the purchase price of that dwelling occupied, entirely or in part, by the purchaser.

In plain English, this means California is for most homeowners a non-recourse state when it comes to “purchase money mortgages.” These are mortgages, including in some cases second mortgages, that were taken out in order to purchase a house that the buyer actually lived in.

California’s Anti-deficiency Laws: Who’s Protected

Three major groups of California mortgage debtors are thus excluded from the protection of California’s pro-homeowner C.C.P. 580b: (1) Investors who purchased homes in order to flip them without ever intending on living or renting in them (2) investors who purchase a property as a rental (3) homeowners who take on additional mortgage debt after purchasing their house.

California also has a second law protecting mortgage debtors from their banks: C.C.P. 580d. This law covers all housing debt, including HELOCs, home improvement loans, and 2nd mortgages, but the law only applies to non-judicial foreclosures. These creditors can still collect the remaining debt in a judicial foreclosure.

Anti-deficiency Laws in Practice: An Example

Here is a scenario showing how 580b and 580d work together:

Bob purchased a house with $0 down and a 500K interest-only mortgage. After the value of his house went up he took out a 2nd mortgage, on which he owes 100K. Now his house is worth 400K and has 600K in mortgage debt.

Let’s say Bob stops paying and his house is foreclosed and sold for 400K. That leaves 200K in debt unpaid. The first lender gets all of the 400K, but cannot get the 100K remaining that Bob owes.

The second lender now has a choice. It can just eat the entire 100K loss, or it can go the route of a judicial foreclosure. The bank probably won’t do that if Bob has little assets and lots of debt, but if Bob has a high-paying steady job the lender just might try: $100,000 is a lot of money to lose.

In these circumstances, Bob’s best strategy is probably to stop paying the 1st mortgage but to keep paying the 2nd. There are a lot of complicated rules and strict time limits involved with a judicial foreclosure. If Bob keeps paying lender 2 while he stops paying lender 1 and waits for lender 1 to foreclose, the chance of lender 2 noticing and undertaking the complicated judicial foreclosure process on time is lower than if Bob stiffs both lenders at the same time. Further, the amount owed to lender 2 will decrease as payments keep getting made, so the value of seeking a deficiency judgment decreases.

It’s Best to Talk to a Lawyer First

Someone considering walking away from their mortgage but wants to protect his income and his other assets from his banks would best be advised to seek the assistance of a licensed California attorney who could advise them on a number of issues, such as:

– Can the bank use some other legal means of pushing its loss onto the former owner, for example under an equitable or tort theory? Assuming the bank tries, does it have any chance of winning?

– Does 580b protect a homeowner who bought a condo as an investment and rented it out for a year, then moved in himself, and then stopped paying the mortgage?

– What are the state and federal income tax consequences of a foreclosure?

Lawyers are not cheap, but the mortgage companies all have their own army of lawyers and collections personnel. Would you really want to go it alone against them?

This article does not constitute legal advice or the formation of an attorney-client relationship, and is not for re-publication without express permission of the author.

Greg Weston is an experienced business litigator licensed to practice law in California and Florida, and is a graduate of Harvard Law School. Mr. Weston’s frequently represents individuals and small businesses against large corporations, including cases involving condominium purchase agreements and other real estate investments. He can be reached at (619) 255-7098 or greg@thewestonfirm.com.



8 responses to “Jingle Mail and California Law: Giving the mortgage back to the bank

  1. What about non cash-out refis?

  2. I think I read elsewhere that the 2nd lender can still collect from Bob, because they don’t have the ability to foreclose once the 1st lender has done so. In other words, they can sue and get a judgment after the house is gone. Perhaps you should double check that.

  3. Foreclose me:

    My reading of the law is that a situation involving a second mortgage taken out at the same time as the first one, and used to purchase a residential property, the 2nd lender has no recourse.

    That’s why in all the 80/20 and 80/15 loans that were once common here in California the interest rate was much higher on the second loan. The risk to the 2nd lender was much higher.

  4. Greg-I believe there’s a distinction b/w those LOC 2nds that were drawn down, paid off then drawn down again, vs those that were only drawn down. The latter is considered a purchase money loan, the former isn’t.

    Thanks for the good info – very much enjoy your blogging.

  5. I recently foreclosed on my house in CA, and I had an 80/20 loans, only purchase-money loans, and the second lender is trying to collect now. Apparently, AIG insured the loan (probably paid for by the higher interest rate), and and now AIG is trying to collect. It was a trustee sale, and the second lender was wiped out completely. Now I have a lawyer in Sacramento to help deal with this. The first lender will be lucky to recover 75%. Does anyone else have the same situation?

  6. They can sue and get a judgment after the house is gone.

  7. My attorney has advised the same. If the first and second are taken out at the same time the junior has no recourse.

  8. What do you make of the Simon v. Superior Court decision (1992) and its applicability to instances where the same lender holds both the first and the second notes? The holding suggests that the lender cannot seek a deficiency judgment when it exercised its power of sale to satisfy the senior note. Does this change when the bank seeks a judicial foreclosure? What’s the analysis for how the bank chooses to pursue the foreclosure (i.e., power of sale v. judicial foreclosure)?

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