1. What is the purpose of California’s anti-deficiency rules?

Anti-deficiency laws protect homeowners from personal liability for payments on debt secured by real estate.

These laws prevent lenders from pursuing homeowners in court when they default on their mortgage, for anything beyond the real estate itself. In these cases, the lenders’ only remedy is the real estate that secures the loan.

For example, consider a homeowner who purchases at the height of the market with a mortgage secured by their primary residence. After the market cools off and home values have dropped, they lose their job and are no longer able to make mortgage payments. They default and the lender forecloses on the property. However, the value of the foreclosed property is lower than the remaining mortgage debt (a condition called negative equity). Is the lender able to collect additional money from the foreclosed homeowner?

No! Due to California’s anti-deficiency protections on nonrecourse mortgages, the collection of any underpaid amount is limited by anti-deficiency rules to the value of the property at the time of payoff, in this case, foreclosure. [California Code of Civil Procedure §580b(a)]

2. What are anti-deficiency rules in California?

When a buyer exercises their put option and defaults on their mortgage, the lender collects on their losses by selling the property at a foreclosure sale. Occasionally, the fair market value (FMV) of the secured real estate is insufficient to satisfy the debt at the time of a foreclosure sale. Yet borrowers of nonrecourse mortgages are not personally responsible for the deficiency remaining. They are protected by the state’s anti-deficiency rules.

Not all mortgages are protected by anti-deficiency rules. In California, nonrecourse mortgages, also known as purchase-money debt and anti-deficiency debt, include:

  • purchase-assist financing by a lender on a one-to-four unit residential property to be occupied by the buyer;
  • carryback financing arrangements evidencing the installment sale of any type of property; and
  • refinanced purchase-money mortgages, to the extent the funding is applied to pay off the replaced purchase money mortgage. [CCP 580b(a)]

Purchase-money debt does not include purchase-assist loans which fund the purchase of property other than buyer-occupied one-to-four residential units.

3. Are non-occupying buyers protected by anti-deficiency rules?

Whether a non-occupying buyer is protected by anti-deficiency rules depends on how their mortgage was originated.

Purchase-assist financing originated by a non-occupying buyer of any type of property, including one-to-four residential units, is a recourse mortgage and the buyer is not protected by anti-deficiency rules from a deficiency judgment.

However, a non-occupying buyer who takes over a nonrecourse mortgage under any procedure is entitled to anti-deficiency protection. For example, a non-occupying buyer who receives a mortgage assumption of a nonrecourse mortgage or a nonrecourse mortgage originated by a carryback seller are protected by anti-deficiency rules.  [Jackson v. Taylor (1969) 272 CA2d 1]

4. Do lenders collect on deficiencies in practice?

Lenders may collect on recourse debt — any debt not included in the nonrecourse mortgage definition — but they need to take some extra steps to maintain their ability to collect.

To collect on a recourse debt, the lender first needs to exhaust the security by completing a judicial foreclosure when:

  • the court-appraised value of the property at the time of the judicial foreclosure sale is less than the debt; and
  • the bid at the judicial foreclosure sale is for less than the debt.

California is a nonjudicial foreclosure state, meaning the standard foreclosure process can skip the lengthy court process required by judicial foreclosure sales. Therefore, lenders who pursue recourse mortgages need to be willing to wait the extra time and pay the extra costs associated with judicial foreclosures. Hence, lenders pursuing collection of a recourse mortgage is rare.

Further, a carryback seller who wishes to collect on a recourse debt can only do so if the property is sold in a judicial foreclosure sale. [In re Salamon (9th Cir. BAP 2017)  854 F3d 632]

5. What are the conflicts between California’s anti-deficiency laws and mortgages insured or guaranteed at the federal level?

Despite California anti-deficiency law and due to federal preemption, nonrecourse mortgages insured by the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA) are subject to government recovery of these unpaid mortgage debts.  The federal statutory right to collect losses on these types of mortgages preempts state law to the contrary. [Carter v. Derwinski (9th Cir. 1993) 987 F2d 611]

The Department of Housing and Urban Development (HUD), which administers the FHA, may require lenders to pursue deficiency judgments. HUD states their intention is to prevent mortgagor abuse, specifically by focusing on:

  • non-owner-occupant homeowners;
  • those who have previously defaulted on one or more FHA-insured mortgages; or
  • homeowners who have chosen to strategically default. [HUD Mortgagee Letter 89-14]

However, the FHA and VA rarely exercise this right to recover. In fact, the FHA has not exercised its right to collect on a deficiency in California in over 20 years.

6. Are there other exceptions to California’s anti-deficiency laws?

There are some exceptions to the state’s anti-deficiency laws.

For example, consider a carryback seller of a rental property who locates a buyer, negotiating terms to allow the buyer to assume their mortgage and execute a note and trust deed in favor of the seller. A few months after the note is executed, the new owner is found to be rent skimming — when a landlord collects rents from their tenant without paying mortgage payments on the rental property.

The carryback seller is entitled to their actual money losses caused by an investor’s act of rent skimming, collectible despite anti-deficiency laws.

The seller’s recovery includes the amount owed under a carryback note, land sales contract or lease-option, unless fully satisfied by the high bid at the foreclosure sale. Additionally, the carryback seller is entitled to collect other money losses caused by the rent skimming investor’s activities, such as waste. The carryback seller is further entitled to punitive losses of no less than three times their out-of-pocket losses when the investor participated in multiple acts of rent skimming, one being the seller’s property. [CC §891(a)]

The situation would be different if, instead of dealing with a carryback seller, the rent skimming landlord held a mortgage granted by a lender. An investor engaged in multiple acts of rent skimming is also liable to mortgage holders for money losses incurred on mortgages secured by one of the properties involved in the multiple acts of rent skimming. However, lender recovery is limited to the rents collected on the property, whether or not the investor obtained or assumed the mortgage. [CC §891(c)]

Additionally, when on a foreclosure a mortgage holder loses money caused by a lowering of the property’s value due to the homeowner’s bad-faith neglect, called waste, they may collect the waste-related loss from the homeowner.

Waste needs to be malicious or excessively damaging to the property to be considered in bad faith, as opposed to natural deterioration of the property’s value over time. The lender holding nonrecourse mortgage debt may only recover the devaluation to the property brought on by bad-faith waste, and then only when the lender underbids to take a loss on the foreclosure sale. [Cornelison v. Kornbluth (1975) 15 CA3d 590]

7. Where can I read more?

Read more about the FHA’s and VA’s rights to collect on deficiency judgments here.

Read more about the history of anti-deficiency rules in California here.

first tuesday students, read more about anti-deficiency laws in California in Real Estate Finance: Chapter 40: Anti-deficiency: past, present and future, accessible online via your student homepage.

first tuesday students, read more about mortgage assumptions in Real Estate Finance: Chapter 20: Assumptions: formal and subject-to, accessible online via your student homepage.

first tuesday students, read more about the exceptions to anti-deficiency rules in Real Estate Finance: Chapter 41: Converting nonrecourse debt to recourse debt, accessible online via your student homepage.