September 21, 2010

Anti-deficiency Real Estate Laws in California

In response to the Great Depression of the 1930s, the California legislature passed a series of borrower-friendly laws that severely restricted the remedies available to lenders in case of foreclosure. 

These laws bar deficiency judgments in the case of non-judicial foreclosure, Civil Code Section 580d, and purchase money mortgages, Civil Code Section 580b. The focus of this post is to show the relationship between the anti-deficiency laws and estate planning. Yes, there is a connection.   

In short, Civil Code Section 580d and Civil Code Section 580b say that in the case of a (1) non-judicial foreclosure sale of real property or (2) a property secured by  purchase money mortgage, a deficiency judgment will be prohibited in both instances. Now that I have given the lawyer's definition of the anti-deficiency law I can proceed with the everyday language explanation.

1. Non-judicial Foreclosure

A non-judicial foreclosure is a transaction done outside of court supervision. The sale usually occurs on the courthouse steps. For example, in Santa Clara County, non-judicial foreclosure sales happen routinely at 10:00 am on the backside of the Superior Court located at 191 N First Street San Jose, CA 95113.

2. Purchase money mortgage

A purchase money mortgage is a mortgage in which the loan proceeds are applied to the purchase of home itself. For example, borrower obtains a loan from lender to purchase his residential home. This would qualify as a purchase money mortgage.

3. Deficiency judgment

A deficiency judgment occurs in a foreclosure sale when the asset securing the loan is sold for less than the value of the loan. For example, borrower obtains a $400k loan on a $500k home in 2005. In 2010, the loan has been paid down to $375k but the home is now $200k. Borrower, unable to make the payments due to financial hardship, losses the home to a foreclosure sale in 2010. At this foreclosure sale, the house is sold for $200k. Since the lender cannot recoup its money from the foreclosure sale, the bank would like to pursue a deficiency judgment against the borrower for $175k.

Civil Code Section 580(b), (d) and Estate Planning

Now that you have a decent understanding of the nuances of the anti-deficiency laws, you should be able to apply these laws to estate planning.

Assume that you are either the successor trustee of your parents' living trust or you are the executor of your parents' probate estate. Your parents purchased their family home a few years during the boom years of the 2000s. Now in 2010 however, the house is under water in that the value of the home is eclipsed by the value of the loan. The loan is $500k and the home is worth $350k for instance. Furthermore, your parents' estate lacks the necessary liquidity to pay off the mortgage, namely your parents' estate is cash poor. You are concerned that the bank will foreclose on the property and seek a deficiency judgment against the other assets of your parents' estate, presumably your inheritance. However, Civil Code Section 580b explicitly bars such an action by the bank because the mortgage was a purchase money mortgage. Thus, the deficiency incurred as a result of the foreclosure sale of your parents' home will not affect the other assets of the estate.