Ending deficiency judgments in Calif. short sales

magnifying glass spotlights short sale newsI’ve been working with distressed homeowners in Mar Vista, Westchester, Beverlywood and Cheviot Hills who are reluctant to explore short sale options because of possible deficiency judgments.

They can breathe a little easier with the arrival of a new state law that prohibits first-mortgage holders from seeking judgments against homeowners once a short sale has been accepted.

State Senate Bill 931 was signed by Gov. Schwarzenegger last fall and now has become California law as Section 580e of the Code of Civil Procedure.

Specifically, 580e prohibits banks from seeking a deficiency judgment from you personally after they have consented, in writing, to accepting a short sale in lieu of foreclosure. It obligates the mortgage holder to forgive and forget about whatever remains of your indebtedness once a short sale is a done deal.

The law applies to both owner-occupied and and investment property, but it doesn’t cover buildings with more than four units.

What is missing in the passage of SB 931 for Westside homeowners is legal protection from lenders in second-lien positions. So if you took a second mortgage on the property after you bought it, or refinanced to get better terms or tapped into the equity, you’re still in danger of a deficiency judgment.

Bills.com explains how California’s tricky “recourse rules” apply:

“If the second mortgage was taken out at the time of sale and was used as purchase money loan then it is a non-recourse loan. However, if the second mortgage was financed after the initial purchase of the property and is on a second deed, then Section 580b does not apply (and it is a recourse loan). Similarly, Section 580b also does not apply when the borrower has refinanced the property to take out additional equity or obtain financing at better terms.”

So if your lender in the second position is not properly negotiated with, that debtor can pursue a judgment (within the four-year statute of limitations). The lender might even sell your loan to collectors.  Update:  July 2011  Lenders in second lien position cannot seek a deficiency judgement.

Fortunately for the home sellers on the Westside, my team of negotiators examines all potential lender complications in the short sale approval letter concerning first- and second-position loans. We don’t stop negotiating with your lenders until the deal is closed and you can walk away from your underwater home with no regrets.

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