If I still owe money after a foreclosure, do I need to file for bankruptcy in California?

In most California foreclosures, you won't owe a deficiency so bankruptcy won't be necessary. But there are a few exceptions.

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Question

I lost my house to a foreclosure. I only had one mortgage on the property, but I’m worried that I might still owe money to the lender since I owed a lot more than the house was worth. Do I need to file for bankruptcy? I live in California.

Answer

Probably not. In California, even if you’re underwater (you owe more than your home is worth), most homeowners don’t owe the lender any money after a foreclosure sale. This means that filing bankruptcy is usually not necessary.

However, depending on the facts of your particular situation, the lender could potentially come after you for the difference between the sale price and the total debt (called a deficiency). If that happens, you may want to file bankruptcy to wipe out the debt.

Understanding Deficiencies After a Foreclosure

In a foreclosure, the total debt owed by the borrower to the lender may be more than the foreclosure sale price. This results in a “deficiency.” The deficiency could be a sizeable amount if you’re significantly underwater.

Example. If you owe $300,000 on your home, but it only sells for $200,000 at the foreclosure sale, then the deficiency is $100,000.

In some states, including California, the lender can seek a personal judgment against the borrower to recover the deficiency under certain limited circumstances. Generally, once the lender gets a deficiency judgment, it may collect this amount (in our example, $100,000) from the borrower by doing such things as garnishing wages or levying a bank account. (To learn more, see Deficiency Judgments After Foreclosure: Will I Still Owe Money?)

When the Lender Can Get a Deficiency Judgment in California

In California, foreclosures can be either judicial (which means the case goes through the state court system) or nonjudicial (there is no court supervision). (Learn more about the differences between judicial and nonjudicial foreclosures in Will Your Foreclosure Take Place In or Out of Court?)

The Lender Cannot Get a Deficiency Judgment After a Nonjudicial Foreclosure in California

Under California law, the lender cannot get a deficiency judgment against you if it uses a nonjudicial foreclosure process. (Learn more about how the California nonjudicial foreclosure process works.)

Most residential foreclosures in California are nonjudicial. So, if you (like most other California homeowners) went through a nonjudicial foreclosure, you’re off the hook when it comes to a deficiency judgment. You wouldn't need to file for bankruptcy to get rid of the deficiency.

The Lender Can Sometimes Get a Deficiency Judgment After a Judicial Foreclosure in California

On the other hand, if the lender forecloses judicially (by filing a lawsuit in state court), then a deficiency judgment is generally allowed in California, subject to a few important exceptions.

California law prohibits a deficiency judgment, even if the lender uses judicial foreclosure, for the following types of loans:

  • Purchase-money loans. If you took out the loan out to buy a home that you occupy, which has four or fewer units (called a "purchase-money loan"), the lender cannot get a deficiency judgment.
  • Seller-financed loans. If you got the loan from the person or entity who sold the property to you, the lender cannot get a deficiency judgment.
  • Refinanced purchase-money loans. The lender also cannot get a deficiency judgment if the foreclosed loan was a re-financed purchase-money loan taken out on or after January 1, 2013, except to the extent that you took out new principal that was not applied to the purchase-money loan. (The anti-deficiency protection also does not cover fees, costs, or related expenses of the refinance.)

As you can see, these restrictions significantly curtail the lender’s ability to get a deficiency judgment against a California homeowner. (Learn more about Deficiency Judgments After Foreclosure in California.)

When to Consider Filing Bankruptcy

If your lender foreclosed judicially and you do not fall under any of the exceptions listed in the section above, then filing for bankruptcy relief might be a good idea.

For example, say you took out a loan and purchased a single-family house that you rented out. (The loan was not seller-financed.) You could be subject to a deficiency judgment if the lender forecloses judicially. In this scenario, filing bankruptcy might help you. With bankruptcy, you can discharge (eliminate) your personal liability for the debt. (Find out more about filing bankruptcy to avoid paying a deficiency judgment.)

If you’re thinking about filing for bankruptcy, you should speak to a qualified attorney who can advise you what to do in your particular situation.

by: , Contributing Editor

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