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Article of the Month for December 2003 Printer friendly version

CA Foreclosure Deficiency Rules

The general rule in California is that a lender, secured by a trust deed against real property, cannot recover any loan deficiency from a borrower if the beneficiary uses the non-judicial trustee's sale procedure to process their foreclosure. The foreclosing beneficiary must, right from the very beginning, use the longer, more involved, judicial approach as a pre-requisite to obtaining a deficiency judgment. Furthermore, any lender who makes a "purchase money" type loan is barred altogether from pursuing any deficiency action against the borrower, regardless of the type of foreclosure procedure used.

So the only instances where a secured lender can try to recover a deficiency is,

  1. when they are not bound by California law (FHA/VA loans are insured or guaranteed by the federal government who's laws and regs are superior to conflicting state laws), or
  2. when a "hard money" loan was made for purposes other than that of purchasing the secured property.

FHA/VA Loans. Nowadays these federally insured or guaranteed loans incorporate enforceable provisions allowing the federal government (HUD) to sue to collect whatever deficiency that might result upon the foreclosure of these loans, regardless of the anti-deficiency statutes of some states such as California's, and regardless of the foreclosure procedure (judicial or non-judicial) that was employed by the originating lender.

"Hard Money" Loans. If a homeowner borrows cash and guarantees its repayment by giving the lender a promissory note and deed of trust against real property that he or she already owns, the loan is characterized as a "hard money" loan. There are two different scenarios where such a loan could lead to a deficiency judgment against the borrower. In the first instance the lender would just simply sue on their newly unsecured promissory note. In the other instance they could go the judicial foreclosure route.

For example, if a hard money loan was originally secured by a junior trust deed and then was subsequently wiped off the title to the property by the foreclosure of a senior lien, the junior loan would still be outstanding and due. But it wouldn't be secured by a specific trust deed to any real property any more. In that instance the lender could go to court and sue the borrower for payment on the defaulted promissory note. Once the lender received their money judgment from the court they could record an abstract of it at the county recorder's office and it would automatically attach, by operation of law, to any and all real property in the name of the judgment debtor. In California money judgments earn the legal rate of interest of 10% per annum. They are good for ten years and are virtually renewable over and over again.

Now, on the other hand, let's suppose it's the "hard money" junior lender who is the foreclosing beneficiary and that they fear they might get the title to the property rather than being paid off at their foreclosure sale. And they further fear that they won't be able to resell the property for enough to net them all of their money in the deal. In such an instance the "hard money" lender could opt to foreclose judicially in order to prepare the legal groundwork to take a deficiency judgment against the borrower - just in case they do come up short upon the ultimate resale of the property.

Though it's possible that a "hard money" lender might elect to pursue a judicial foreclosure with the intention of acquiring a deficiency judgment against the borrower, in reality lenders don't want to spend the extra bucks and time to do it.

So the only real problem in this whole area seems to be HUD's apparent willingness to pursue deficiency actions against their FHA/VA borrowers if HUD's repo sale generates less than what they're owed.

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