Category Archives: jingle mail

Jingle Mail and 2nd Mortgages

I’ve discussed Jingle Mail several times, which is when a borrower owes more on his mortgage than his residential property is worth, and makes the rational decision to give the house back to the bank by mailing back the keys of the house to the bank.

I’ve been e-mailed and asked via blog comments on what the law is for jingle mail and second mortgages in California. The key question is “Can the banks come after me for the difference between the mortgage price and the market price of the house.”

Let’s have a look at how the law plays out under several typical situations.

In the following examples I use the shorthand “H” for homeowner and “B1, B2” for Bank 1, Bank 2, and so on.

Scenario 1

In 2006 H purchases his residence for $1,000,000. He pays for the house using funds from three sources: (1) a traditional first mortgage for $800,000 from B1; (2) an additional 5-year-ARM for $150,000 from B2; (3) a $50,000 down payment from H’s savings.

The value of H’s house, however, has now dropped in 2008 to $700,000, and he still owes $920,000 on his two mortgages. He decides to stop paying both of them, and the two lenders foreclose, and sell the house for $700,000 at auction.

Can either B1 or B2 go after H for their shared $220,000 loss on the mortgage?

Answer:

No. In this simplest scenario, the borrower is completely protected. He can walk away from his house, and the banks have no remedy other than foreclosing on the house. They cannot sue the borrower, and cannot go after his other assets. California provides no remedy for banks other than foreclosure on purchase money mortgages on residential real estate when the borrower lives in the house.

Scenario 2

H has two mortgages:

– 1st mortgage from B1 that he used to buy his house

– 2nd mortgage from B2 he took out a few months later.

H stops paying first mortgage to B1, which responds with a  non-judicial foreclosure of H’s house. After H moves out and the house is taken by B1, H stops paying his second mortgage to B2. Can B2 go after H’s assets in a judicial foreclosure?

Answer:

Maybe. It was B1’s decision, not B2’s, to proceed with a non-judicial foreclosure for the obvious reason that the slower and more costly judicial foreclosure process would not get it any better a result because the first mortgage was a purchase money mortgage.

But the 2nd mortgage was not for purchase money, so B2 does have a reason to prefer a judicial foreclosure because it could obtain a deficiency judgment. As the California Court of Appeal noted in In re the Marriage of Anthony and Charlotte Oropallo:

It is true that when the security of a second deed of trust is rendered valueless by a prior foreclosure, through no fault or action of the second lender, that lender for equitable reasons will ordinarily be permitted an action against the debtor on the second obligation.

Note, however, the qualifications the Court uses. It does not say “always” but instead says “ordinarily” may a 2nd non-purchase-money lender pursue a deficiency judgment against a borrower. Note also that the Court says a deficiency action “ordinarily” is allowed when the mortgage is rendered valueless “through no fault or action of the second lender.” The remedy is allowed not as a matter of law, but as a matter of equity, and a bank cannot receive the benefits of equity unless its own behavior was equitable.

H, however, might be able to argue that B2 was at least in part (if not mostly or entirely) for the foreclosure. Is B2 known for seeking out and writing mortgages based on inflated appraisals? Did the B2 target homeowners with poor credit, knowing that it could charge such homeowners higher interest rates and more fees? Did B2 actually verify the buyer’s income, or was it a no-doc loan that it bought from one of the dozens of now-bankrupt subprime brokers? Was B2 already equitably compensated for H’s default by charging and receiving above-market interest rates and a host of fees?

Scenario 2 is winnable by either party, or the decision could be split, with B2 being awarded a judgment for a substantial sum, but less than its full loss. In practice, if H puts up a spirited defense to B2’s lawsuit, H will probably either win the case early by

(1) showing a procedural defect in the foreclosure or B2’s pleadings

(2) or proving inequitable conduct on B2’s part.

Failing that, H will probably be able to convince B2’s attorneys to settle for a smaller sum than the amount he defaulted on.

Scenario 3

H buys his house with a mortgage from B1. Some time later, he takes out a second mortgage, again from B1. He then stops paying both mortgages and B1 forecloses on the house in a nonjudicial foreclosure. The sale of the house does not bring enough to pay off the first mortgage, much less the second.

Since the 2nd mortgage was not a purchase money mortgage subject to the protections of Cal. C.C.P. 580b, can B1 obtain a deficiency judgment for the second mortgage in a judicial foreclosure?

Answer:

No. In Simon v. Superior Court, 4 Cal. App. 4th 63 (1992), a bank tried to go after a borrower in a judicial foreclosure on the second non-purchase-money mortgage after it had already taken the property in a non-judicial foreclosure after a default on the first mortgage.

This is good news for homeowners who have a 2nd mortgage they took out later from the same bank they used for their first mortgage. In many cases a bank may not know the size of a deficiency until after it has already proceeded with a non-judicial foreclosure of the first mortgage. At that point, it is out of luck and will have to eat the loss with the 2nd mortgage (or, quite commonly, a HELOC on top of the first mortgage).

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 a graduate of Harvard Law School and experienced business attorney licensed in California and Florida. Mr. Weston’s San Diego-based practice focuses on representing 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. Comments about the blog via e-mail are welcomed.

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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.