More and more Americans are facing a decision on mortgage debt they are unable to pay or refinance. Should I declare bankruptcy? You may not have to. You may be able to simply walk away from the mortgage. Most Americans fear making that choice.
The Bank Chase for a Deficiency Judgment
Most Americans believe if they walk away from their mortgage payments, the bank will foreclose, the house sold and they will still be liable for the balance of the loan debt, known as a deficiency judgment. As a result, they believe they need to declare bankruptcy (under Chapter 7 or 13) to protect them from the deficiency judgment. This may not be true.
Just Walk Away Renee
In some title theory states, like California, the homeowner is NOT liable for a loan deficiency judgment if:
- the mortgage is on the principal residence and used solely to purchase the house (sometimes known as a first mortgage or purchase money mortgage- not refinanced mortgages, equity lines of credit or second mortgages) OR
- the lender chooses non-judicial foreclosure (an auction by a trustee not involving the courts) [Cal. Civ. Proc. Code Sec. 580(d]. This is quite common.
Under the one-action rule, banks in California, which normally choose a non-judicial foreclosure under a power of sale clause (it’s faster and easier ), are not permitted under law to start a second action to collect the deficiency debt from the homeowner borrower.
In most other states, where you are liable for a deficiency judgment, or where a judicial foreclosure is available, there are time consuming and costly legal hurdles to jump and many banks chose not to come after the homeowner for any deficiency. But banks won’t tell you this. Therefore, you may be able to walk away from the mortgage without declaring bankruptcy to escape the deficiency judgment.
Before choosing to walk away from your mortgage, get legal advice from an attorney in your state who is experienced in this area of real estate law.
The Feds Will Forgive You
If you do walk from your home mortgage and the bank does not chase you for the difference — in effect, forgives the debt balance, you escape paying income tax because of the recently passed (September 2007) Mortgage Forgiveness Debt Relief Act which does not tax forgiven mortgage debt on a principal residence, whether through refinancing or foreclosure.
Further Reading:
US Foreclosure laws (a general state-by-state guide, not legal advice)
[Author’s Disclaimer: Since I am not licensed to practice law in California (just in NY & Texas), this post should not be considered a legal opinion. It is an opinion from some guy in New York. Hey, what do you want for free? Talk to a lawyer in your state before you do anything.)
Technorati Tags: foreclosure, deficiency judgment, California, one action rule, title theory
Hi Joe
What about the case where the bank walks away from the asset itself-who is responsible then? Should the local municipality have the right to force the bank or the owner of record to maintain the property. Who owes the taxes on the vacant property?
Joe:
Wish you WERE licensed to practice law in California.
Joe,
Your link is the the House version which was amended by the Senate. Here is a link to the bill that was signed into law:
http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=110_cong_bills&docid=f:h3648enr.txt.pdf
Also, there are exceptions to the debt forgiveness law. The debt has to be acquisition debt. If there was a refi, only that amount equal to the original acquisition debt or debt used for “substantial improvements” to the property. So if you refi the original purchase money loan(s) to get a better rate, you’re good. If you do a cash out refi to build a garage, you’re good. If you cash out to buy an Escalade to put into the garage, that debt is taxable. Here is an overview.
Thanks Bob. I changed the link.
Hi Joe - I did not know this, and will check to see how this is handled in NH. Not that I would encourage people to walk away, but if applies here in NH and/or Maine, it would be helpful for folks in those situations to know about it. Where would one start looking in order to try to find this information out for their own state?
Thank you for writing about this!
Hi Ann
I would start by calling real estate and bankruptcy lawyers and have them cite the law, or better yet, send you a copy of it and tell you the circumstances, if any, where a homeowner is safe from a deficiency judgment. See if NH has a one-action rule similar to CA and if banks typically sue for the deficiency. (This may be a bank by bank policy) .
I would be a little suspect of their opinion if they can’t cite the law.
NH allows non-judicial foreclosure under a power of sale clause.
UPDATE: Mortgages law in NH: http://www.gencourt.state.nh.us/rsa/html/nhtoc/nhtoc-xlviii-479.htm
In florida…they leave the door open to come back after the homeowner and the option to do so is written in every final judgment.
It allows the Court to maintain jurisdiction and the Bank need not even file a new lawsuit. It is however subject to the Statute of Limitations.
However, I have NEVER seen a bank file for a deficiency judgments and I have seen some really bad cases wherein the bank should have.
But because here in Florida they have years to come back, we may not have yet seen the the iceberg beneath the water.
Brett - generally the cost of bringing the deficiency judgement is such that many lenders or banks in the state of Florida will not pursue it.
Joe:
I know you don’t practice in California but I have a question about our non-judicial foreclosure process.
If a homeowner borrows $500,000 to buy a home, later refinances for $600,000 and eventually sells for $525,000, the deficiency is $75,000.
Under the one-action rule, if the lender pursues the non-judicial route, does that trump the refi amount being owed. In other words, must the lender pursue judicial foreclosure to recover the deficiency (since it was refinanced and cash was withdrawn?
Brian, I believe the answer is yes, under 580 (d)
As I read the statute, under 580 (b) the anti-deficiency judgment protection only applies to purchase money mortgages (not refis, HEs or seconds).
BUT under 580(d), your borrower would be protected under the one-action rule if the bank chose a non-judicial foreclosure trustee sale under the power of sale clause, so long as the mortgage covered $600K.
If you have the time or inclination, check with a CA lawyer and let me know if I am right.
http://tinyurl.com/2roysl
There was a case where a CA bank tried to do a little end-around the law by doing a non-judicial foreclosure in CA and then suing in Kansas for the deficiency judgment. The Court said nice try but no. CA law still governed, even in Kansas.
http://tinyurl.com/2vajzn
Thanks…that’s pretty cool (for borrowers).
I haven’t heard of a bank going the judicial route, yet. You gotta think they’d do that if there were other properties available.
Banks usually choose the non-judicial route because of legal technicalities, time and money. I have represented homeowners who were being foreclosed on improperly– where the bank did not follow procedures. The foreclosure action was dismissed and the bank, rather than starting over, refinanced. It pays to know the law.
“It pays to know the law”
…or a good attorney. Thanks, again. I e-mailed one of our attorneys and he said that legally and pragmatically, you’re correct. His comment was that he would be surprised if any judicial foreclosures were pursued for owner-occupied residential properties
Just pass it forward, Brian.
One thing to keep in mind in California where so many properties have a 1st and 2nd with two different lenders is the impact of a cut off junior.
Many mistakenly believe that the non-recourse protection afforded purchase money loans means they can walk from both a 1st and 2nd without consequence. If the 1st forecloses via a trustee sale, Lender A got their one action, but what about the 2nd and Lender B? While it was a purchase money loan, Lender B didn’t get their one action, so they can go after a deficiency.
FWIW, I am seeing lenders pursue deficiencies on cut off juniors and some bank insiders have told me that when the dust clears in few years, they will go after the deficiencies in some instances, particularly the ruthless defaults where ability to pay was there, but the borrower made a “business decision” to walk.
I left out a key phrase when I was editing the previous comment.
After “While it was a purchase money loan, Lender B didn’t get their one action, so they can go after a deficiency.” should have been the following:
“This seems like a contradiction because Sec 580 says it applies to a sold out junior that was a purchase money loan, some lenders are claiming that because the 20% 2nd in the 80/20 is actually a HELOC, it isn’t afforded the protection under 580.”
Sorry for any confusion that may have created.
For those that have done FHA improvement 2nds that funded at close of escrow, HUD was able to seek a deficiency against a CA borrower where the 1st foreclosed and HUD’s improvement loan was the cut off junior. The court ruled that it wasn’t purchase money and allowed HUD to attached wages.
Moral of the story is that consulting an attorney before walking is imperative.
This is relevant to Tax Debt Relief that the banks will not tell you that you may not be liable for a deficiency judgement if you walk away from mortgage. I suggest that we must not do this but we should make the tax payable on time.