Automatic and declared homesteads

This article demonstrates an equity purchaser’s application of the various homestead exemptions available to sellers to create net equity where a judgment or tax lien affects title.

A real estate investor investigates abstracts of judgment recorded by creditors against owners of real estate as a method for locating financially distressed real estate he might be able to buy.

An abstract he has checked out attached as a lien on the principal residence of an individual who owes the creditor $80,000 under the judgment. A declaration of homstead was recorded by the owner before the abstract was recorded. Also, the property is not presently held out “For Sale”.

On completing a comparable market analysis (CMA), the investor concludes the property has a Fair Market Value for his investment purposes of approximately $20,000 more than the first trust deed lien. When considering the $80,000 abstract of judgment which attaches as a lien, the property appears to be over-encumbered and have no equity.

The owner, initially contacted by the investor’s use of a form letter, indicates he needs to sell the home. He has other creditor problems as well as being delinquent on his home loan. He is aware he has a $75,000 homestead to protect him from the judgment creditor selling his home, but doesn’t know how he can sell his home when title is clouded by the abstract.

The investor prepares an offer on a regular purchase agreement loan since a Notice of Default has not been recorded commencing foreclosure. The price is payable $20,000 cash down payment. Two contigency provisions are attached to the purchase agreement, one calling for a 10% discount on a short payoff of the first trust deed loan from cash funds provided by the investor in addition to the down payment, and the other calling for a release of the property from the abstract of judgment held by the creditor. The investor will be given written authorization to negotiate with the lender and the judgment creditor to arrange for the short pay and the release.

When submitting the offer to the owner, the investor explains the approximately $30,000 in down payment and lender discount belongs to the seller, not the judgment creditor, due to the recorded homestead of $75,000.

The lender will be induced to discount since the title is encumbered with liens of $50,000 in excess of the property’s market value. Further, and more compelling is the fact the lender will have to complete a foreclosure due to the existence of the junior lien (abstract) and deteriorating real estate prices. A short pay would be in their best interest to mitigate losses they will otherwise certainly incur.

As for the judgment creditor, he will be asked for a release of the owner’s home on the close of escrow since he has no claims against the property due to the recorded homestead declaration and the lack of more than $75,000 in equity over the amount of the lender’s trust deed lien. Possibly, negotiation may necessitate the payment of $5,000 to $10,000 to motivate the creditor if a threat of quit title action to clear title if his cloud doesn’t do so.

Thus, the seller now has the incentive to accept this offer since he will net some cash from a sale in which the buyer (investor) will be handling negotiations to clear up title and perfect an equity in the property.

Home-equity shield against judgments

A homeowner is sued by a creditor for money owed on an unsecured debt. A money judgment is awarded to the creditor who becomes a judgment creditor. The homeowner becomes a judgment debtor.

An abstract of judgment is recorded by the judgment creditor in the county where the homeowner’s residence is located.

Can the homeowner prevent the recorded abstract from attaching as a lien against the title to his home?

No! However, the type of homestead the homeowner claims — there are two — and the amount of the homestead exemption he qualifies for — there are three — determines the homeowner’s ability to:

voluntarily sell the home and buy another home with the homestead amount he has in his equity; or
bar the judgment creditor from forcing a sale of the home to satisfy the judgment.

The homestead interest in title

A homestead is the dollar amount of the equity in a homeowner’s dwelling which the homeowner qualifies to hold. The amount of the homestead held by the homeowner has priority on title over most judgment liens and some government liens.

Two types of homestead procedures are available to California homeowners to establish the priority of the homestead equity they hold in their home:

the declaration of homestead, which is recorded [Calif. Code of Civil Procedure §704.920]; and
the automatic homestead, also called a statutory homestead exemption, which is not recorded. [CCP §704.720]

Both homestead arrangements provide the same dollar amount of home- equity protection given to all homeowners in California. However, a homeowner must record a declaration of homestead to receive the additional benefits available under the homestead laws allowing the homeowner the right to sell and to reinvest the dollar amount of the homestead in another home.

Neither the declared nor the automatic homestead interfere with:

voluntary liens later placed on the property by the homeowner, such as trust deeds; and
involuntary liens given priority to the homestead exemption under public policy legislation.

Involuntary liens and encumbrances which are given priority by statute and can be enforced as senior to the amount of the homestead exemption include mechanic’s (contractor’s) and vendor’s (seller’s) liens, homeowners’ association (HOA) assessments, judgments for alimony or child support, real estate taxes and Internal Revenue Service (IRS) liens.

Involuntary liens which are subordinate and junior to the homestead amount include:

Franchise Tax Board (FTB) personal income tax liens;
Medi-Cal liens; and
judgment creditor’s liens.

Declaring a homestead

The recorded homestead declaration includes:

the name of the homeowner declaring the homestead;
a description of the property homesteaded; and
a statement that the declared homestead is the principal dwelling of the homeowner in which he resides on the date the homestead is recorded. [CCP §704.930(a)]

The declaration must be signed, notarized and recorded to take effect. [CCP §704.930]

The homestead declaration may be signed and recorded by any one of several individuals, including:

the owner of the homestead;
the owner’s spouse; or
the guardian, conservator, attorney in fact, or a person otherwise authorized to act for the owner or the owner’s spouse. [CCP §704.930(b)]

An individual’s personal residence which is vested in a revocable inter vivos (living) trust, or other type of title holding arrangement established for the benefit of the homeowner, can also be declared a homestead by anyone who has an interest in the property and resides there. [Fisch, Spiegler, Ginsburg & Ladner v. Appel (1992) 10 CA4th 1810]

Additionally, a declaration of homestead in no way restricts the homeowner’s ability to voluntarily sell, convey or encumber his homesteaded property. [CCP §704.940]

A recorded homestead declaration does not appear in credit reports or impact the homeowner’s credit reputation or ability to borrow funds. Title companies disregard recorded homestead declarations, except in litigation guarantee policies.

Automatic and declared homesteads

An automatic homestead is always available on the principal dwelling occupied by the homeowner or his spouse when:

a judgment creditor’s abstract is recorded against the homeowner and attaches as a lien on the property; and
the occupancy by the homeowner continues until a court determines the dwelling is a homestead. [CCP §704.710(c)]

The automatic homestead exemption applies to the equity in a real estate dwelling (and its outbuildings), a mobilehome, a condominium, a planned development, a stock cooperative or a community apartment project together with the land they rest on, as well as a houseboat or other waterborne vessel used as a dwelling. [CCP §704.710(a)]

On the other hand, a recorded declaration of homestead applies only to real estate dwellings. Thus, mobilehomes not established as real estate and houseboats are not protected by a recorded homestead, only the automatic homestead. Also, a leasehold interest in real estate with an unexpired term of less than two years is not protected by a recorded homestead declaration. [CCP §704.910(c)]

Homesteaded real estate

As long as the homeowner claiming the exemption actually uses the homesteaded property as the principal residence for himself and his family, the type of real estate qualifying for a homestead includes:

two five-room flats [Viotti v. Giomi (1964) 230 CA2d 730];
an 18-unit apartment building where the owner occupies only one unit [Phelps v. Loop (1944) 64 CA2d 332]; and
523 acres of rural land with a house and water rights for the land. [Payne v. Cummings (1905) 146 C 426]

Homeowners qualify for one of three dollar amounts of net equity homestead protection:

a $50,000 equity for a homeowner with no dependents;
a $75,000 equity for a head of household; or
a $150,000 equity for the aged or disabled. [CCP §704.730]

Amount of equity protected

The dollar amount of whichever home equity protection a homeowner qualifies for is protected whether the homeowner relies on the automatic homestead or records a declaration of homestead.

An individual homeowner with no dependents other than himself qualifies for the $50,000 homestead exemption. [CCP §704.730(a)(1)]

A homeowner qualifies for the $75,000 homestead exemption as the head of a household by providing support for a spouse, dependent children, grandchildren, parents, grandparents or in-laws. [CCP §704.730(a)(2)]

An aged or disabled homeowner qualifies for the $150,000 homestead exemption if the homeowner or his spouse is:

65 or older;
physically or mentally disabled; or
55 or older with an annual income of less than $15,000 or, if married, a combined gross annual income of no more than $20,000. [CCP §704.730(a)(3)]

Both a husband and a wife may be the declared homestead owners in the same homestead declaration when both husband and wife own an interest in the property. [CCP §704.930(a)(1)]

However, a couple’s combined homestead exemption cannot exceed the exemption limit for a head of household ($75,000), unless one or both qualify as an aged or disabled person ($150,000). [CCP §704.730(b)]

Further, if both spouses are entitled to a homestead exemption, the homestead proceeds will be apportioned to each spouse according to their share of the ownership in the homesteaded real estate. [CCP §704.730(b)]

Abstract avoids homestead increases

As the legislature increases the amount of the homestead exemptions to keep up with consumer price inflation (not property price inflation), a homeowner does not need to record a new declaration to make the increased amounts available to him since the increased amounts apply to the old declaration.

However, if an involuntary lien is recorded prior to the increase in the amount of the exemption, the amount of equity protected from the attachment is the homestead amount which was available when the lien was recorded, whether the homeowner is claiming an automatic or declared homestead. Thus, inflation or appreciation in the value of the residence may eventually create a home-equity large enough to exceed the homestead amount and provide some recovery for a judgment creditor. [Berhanu v. Metzger (1992) 12 CA4th 445]

Combating a creditor’s sale

A judgment creditor with a recorded abstract of judgment cannot force the sale of an owner’s home to collect on a money judgment without first petitioning a court for its sale, whether the homestead is automatic or by recorded declaration. The court must confirm the owner’s net equity in his home is a dollar amount greater than the amount of the owner’s homestead exemption before the creditor’s judgment can be judicially foreclosed by an execution sale. [CCP §704.740(a)]

For example, the head of a household owes $325,000 on trust deed loans encumbering his home. An unsecured creditor is awarded a money judgment against the homeowner and an abstract is recorded, attaching as a lien on title to the property.

Before the creditor can begin judicial proceedings against the equity in the home to collect on the judgment from the net proceeds of its sale, the home needs a net value in excess of $400,000 — the $325,000 owed on the existing trust deeds plus the $75,000 homestead exemption.

A home with a net equity (after transactional costs) of less than the homestead amount leaves nothing for the creditor to sell in order to collect on the judgment.

Forced sale by court order only

The sale of a homesteaded dwelling can be forced by a creditor if a net equity exists beyond the amount of the homestead the home owner holds in the property. To force the sale of a homeowner’s dwelling, the creditor must first file an application for a judicially ordered sale, called an execution sale, stating under oath:

a description of the property;
whether a declared homestead has been recorded on the property;
the names of the person or persons who claim the homestead;
the amount of the homestead; and
the dollar amounts of all liens and encumbrances recorded on the property and the names and addresses of the lienholders. [CCP §704.760]

If the homestead is declared and the creditor challenges the validity of the declaration, the creditor must prove the property does not qualify for a homestead.

However, if the homeowner has not recorded a declaration of homestead on the property, the homeowner must prove his residency in the dwelling qualifies the property for the automatic homestead exemption. [CCP §704.780(a)(1)]

If the execution sale of the property is ordered by the court and the bids received at the sale are insufficient to satisfy the senior liens and encumbrances, plus the homestead amount and the sales costs, the dwelling will not be ordered sold. [CCP §704.800(a)]

Additionally, a winning bid must exceed 90% of the fair market value (FMV) of the property as set by the court. [CCP §704.800(b)]

A real estate appraiser is often appointed by the court as a reference to assist in determining the FMV of the dwelling. Compensation for the appraiser may not exceed comparable fees for similar services in the community. [CCP §704.780(d)]

If the dwelling is jointly owned by the judgment debtor/homeowner and another person as joint tenants or tenants in common, only the judgment debtor’s interest in the property will be sold. [CCP §704.820(a)]

The proceeds from an execution sale of the dwelling are disbursed in the following order:

pay all senior liens and encumbrances on the property;
disburse the amount of the homestead equity to the homeowner;
cover the costs of the sale;
pay the judgment creditor’s court costs; and
pay the amount due to the creditor from the judgment. [CCP §704.850]

Any remaining proceeds from an execution sale go to the homeowner.

“Drawing down” the homestead amount

Consider a homeowner who records a declaration of homestead on his principal residence which is encumbered by a trust deed. A creditor is later awarded a money judgment against the homeowner and records an abstract of judgment.

The homeowner then records a second trust deed on the residence to secure another loan for an amount less than the dollar amount of his homestead exemption.

The homeowner defaults on the first trust deed loan and the first trust deed holder forecloses on the residence. The residence is sold at a trustee’s sale on a bid in excess of the amount owed to the first trust deed holder.

The judgment lien creditor claims he is entitled to the excess funds since the judgment lien is prior in time to the later recorded second trust deed.

The second trust deed holder claims he is entitled to the remaining funds since the second trust deed lien is a voluntary encumbrance on the homeowner’s equity up to the dollar amount protected by the homestead homeowner’s homestead exemption, which entitles him to first recover against funds due to the homeowner under the recorded declaration of homestead exemption.

Is the second trust deed holder entitled to the excess funds?

Yes! The second trust deed holder is entitled to payment from the funds remaining after satisfaction of the first trust deed debt since the judgment creditor’s lien is subordinate to the recorded declaration of homestead exemption amount. Further, the dollar amount of equity subject to the homestead exemption held by the homeowner under the previously recorded declaration was voluntarily encumbered by the second trust deed lien. [Smith v. James A. Merrill, Inc. (1998) 64 CA4th 94]

Automatic homestead as a shield

Although an automatic homestead exempts some or all of the equity in a homeowner’s dwelling from money judgments obtained by the homeowner’s creditors, use of the automatic homestead is limited to providing a shield, raised by the homeowner, to defend the equity in his house against a forced sale sought by an involuntary creditor.

For example, a homeowner claims his automatic exemption and receives funds in the amount of the homestead equity from a creditor’s forced sale of the home. The homestead funds are protected from the creditor’s attachment during a six- month reinvestment period. Further, an automatic homestead exemption is provided on the replacement residence to protect the reinvested funds. [CCP §704.720(b)]

Editor’s note — Although the proceeds are protected from attachment by the creditor’s lien for the six-month reinvestment period, if the property purchased is in the same county where the lien is recorded, it will not prevent the lien from attaching to new property (subject to the homestead exemption) the instant title is transferred into the buyer’s name.

Thus, a homeowner/debtor intending to purchase a replacement home in the same county with his protected funds will probably not be able to obtain title insurance for a new loan. Title companies will not make a determination as to whether an exemption on the residence is valid. Also, the abstract lien will attach to the property as a lien senior in time to the new lender’s trust deed, unless it is a trust deed carried back by a seller.

The best way to deal with the intervening (judgment) lien is to purchase property either subject to an existing trust deed or by creating a carryback trust deed. Carryback trust deeds have priority over any lien attaching to the title when the buyer takes title, unless the carryback note is specifically subordinated to the previously recorded abstract of judgment. [Calif. Civil Code §2898]

With the automatic homestead exemption, a homeowner who voluntarily sells his residence while title is clouded by a creditor’s lien leaves the sales proceeds unprotected by the automatic exemption. This is not the case for a sale subject to a recorded declaration of homestead, which allows the homeowner to first withdraw his homestead amount from the sales proceeds before the judgment creditor receives any funds.

The exemption in bankruptcy sales

For an individual who files a bankruptcy petition, any sale of the individual’s home during the bankruptcy, whether voluntary or court ordered, is considered a forced sale entitled to the automatic homestead exemption. Thus, a bankruptcy petitioner who voluntarily sells his home (even if the sale is against the bankruptcy court’s order) is still entitled to an automatic homestead exemption on the proceeds of the sale. [In re Reed (9th Cir. 1991) 940 F2d 1317]

Consider a homeowner whose home is being foreclosed on by the first trust deed lender. The homeowner did not file a declaration of homestead prior to the recording of the judgment lien against the property.

At the trustee’s sale, a bid in excess of the loan leaves funds to be disbursed to the junior lienholder (the judgment creditor), since a recorded abstract of judgment against the homeowner exists.

Since foreclosure under a power-of-sale provision is a voluntary sale by private agreement (trust deed provisions) entered into by the homeowner, not a forced sale by a judgment creditor which triggers the automatic homestead exemption, the automatic homestead exemption does not protect the homeowner’s equity on a foreclosure sale of the residence. Thus, the homeowner whose home is lost to foreclosure exposes any excess proceeds from the trustee’s sale to the creditor’s lien, unless a declaration of homestead was recorded prior to recording the creditor’s abstract of judgment. [Spencer v. Lowery (1991) 235 CA3d 1636]

Editor’s note — A homeowner in foreclosure on his home will receive his automatic homestead exemption if he files a bankruptcy petition before the foreclosure is completed. In a bankruptcy proceeding, all sales are considered forced sales. Thus, the dollar amount of the equity covered by the automatic exemption is protected from the claims of involuntary creditors. [In re Reed, supra]

Additionally, the creditor holding a judgment lien (a recorded abstract of judgment) can simply wait until the equity in the home increases, due to inflation, appreciation or loan reduction, when the value of the home exceeds the amount of the homestead exemption, and then begin a forced sale. Thus, the homeowner who relies solely on the automatic homestead exemption to protect his equity is imprisoned in his own home unless he files a bankruptcy petition since he cannot voluntarily sell and avoid the judgment lien.

Although a sufficient net equity may not exist to allow the judgment creditor to force a sale of the home, the homeowner may not use a quiet title action based on an automatic homestead exemption to remove the lien, unlike a declared homestead.

Declared homestead allows resale

A recorded declaration of homestead, in contrast to an automatic homestead exemption, allows a California homeowner to take the offensive against his creditors. Used as a sword, the declaration of homestead coupled with a quiet title action allows the homeowner to sever the liens attached to his title.

Unlike the automatic homestead exemption, judgment liens do not attach to the exempt homestead amount in the equity under a declared homestead if the homestead declaration is recorded prior to the recording of the creditor’s abstract of judgment. [CCP §704.950(a)]

Judgment liens attach to any equity exceeding the amount of the declared homestead exemption and all liens and encumbrances on the declared homestead at the time the abstract of judgment is recorded. [CCP §704.950(c)]

With prior planning, priority of the declaration can be accomplished by the homeowner. While it takes the creditor several months to obtain and record an abstract of judgment, a declaration of homestead can be prepared and recorded on readily available forms in a matter of minutes.

Once recorded, a declaration of homestead lasts until:

the homestead owner records a declaration of abandonment of the homestead; or
the homestead owner records a new declaration of homestead on another residence. [CCP §§704.980, 704.990]

If a homeowner wishes to sell his declared homestead which has become clouded with a creditor’s lien , the homeowner may either:

negotiate a release of the lien with the creditor; or
clear title to the home through a quiet title action based on the priority of his declaration of homestead.

Clearing title of a lien

A quiet title action determines the priorities of the creditor’s lien and the recorded homestead on title. If the homeowner demonstrates the homestead declaration is valid and was recorded prior to the creditor’s lien, the title will be cleared of the lien, provided no equity remains after the homestead amount. [Viotti, supra]

Creditors junior to a declared homestead where no excess equity exists realize their futility in litigation and are generally receptive to a negotiated release. Consequently, the homeowner can usually “buy” a partial (or full) release from the creditor — typically for less than the costs of a quiet title action. [See first tuesday Form 409]

After title is cleared and the homeowner sells his property, he has six months to reinvest the homestead proceeds in another home. If the proceeds are reinvested in a new residence within six months, the new residence may then be declared a homestead by recording a homestead declaration within six months after the purchase.

When the homeowner records a new homestead declaration on his replacement residence, the recording relates back to the time the prior homestead was recorded. This leaves no gap for the creditor’s lien to gain priority over the homestead declaration on the new residence. [CCP §704.960]

If the homestead equity exemption has increased after the creditor recorded his abstract of judgment, the amount of exemption the property owner is entitled to in his new residence is the amount that was in effect when the abstract of judgment was recorded, not the current increased amount.

However, if the homeowner has not invested the proceeds of the sale in a new homestead after six months, and the proceeds are still in the State of California, the proceeds of the homestead sale can be attached by the judgment creditor.

An alternative to vesting title in the judgment debtor’s name is to use a title holding arrangement, such as a corporation or limited liability company (LLC) created by the homeowner to hold title. Thus, the abstract of judgment against the homeowner will not automatically attach to the title held by these entities.

The homestead exemption and CIDs

Consider the prospective buyer of a unit in a common interest development (CID). When entering into the purchase agreement and accepting the seller’s grant deed, the buyer agrees to the CID association’s covenants, conditions, and restrictions (CC&Rs). The CC&Rs include a clause limiting the owner’s ability to claim a homestead exemption senior to any judgment obtained by the association. [CCP §704.710]

The buyer, now an owner, fails to pay the association’s assessment (HOA) fees. The association has two remedies available to collect the unpaid HOA assessment:

record an assessment lien and commence a trustee foreclosure and if not paid, sell the property at a trustee’s sale; or
sue the owner who owes the assessment and obtain a judgment and record an abstract as a lien on the owner’s unit(s).

If the association sues and obtains a judgment against the owner, the CC&Rs bar the homestead exemption from taking a senior position over the association’s judgment. Since the owner initially agreed to the clause in the CC&Rs, the judgment becomes a voluntary lien on the owner’s unit, and is thus unprotected by the homestead exemption.

However, a foreclosure on any assessment lien obtained by the association is considered an involuntary lien that is always senior to the owner’s homestead exemption. [CCP §703.010(b)]