In some states, you might owe your mortgage lender money after a foreclosure sale of your home. This is called a deficiency. In most residential foreclosures in California, the foreclosing lender cannot go after the homeowner for a deficiency. But there are some exceptions.
Read on to learn what a deficiency judgment is, if your mortgage lender can collect one against you in California, and what happens to the deficiency in California if you sell your home through a short sale or use a deed in lieu of foreclosure.
When a lender forecloses on a mortgage, the total debt owed by the borrower to the lender who is foreclosing frequently exceeds the foreclosure sale price. The difference between the sale price and the total debt is called a “deficiency.”
Example. Say the total debt owed on the first mortgage is $200,000, but the home only sells for $150,000 at the foreclosure sale. The deficiency is $50,000.
In some states, the lender can seek a personal judgment against the borrower to recover the deficiency. Generally, once a deficiency judgment has been obtained, the lender may collect this amount (in our example, $50,000) from the borrower by doing such things as garnishing wages or levying a bank account.
(To learn more about deficiency judgments in the foreclosure context, see our Deficiency Judgments After Foreclosure area.)
In California, foreclosures can be either judicial or nonjudicial. Judicial foreclosures are administered though the state court system, while nonjudicial foreclosures have no court supervision and are handled by a trustee. Most residential foreclosures in California are nonjudicial.
(For more on the difference between judicial and nonjudicial foreclosures, and the typical process for each, see How Foreclosure Works.)
In California, a lender cannot get a deficiency judgment after a nonjudicial foreclosure. (Cal. Code Civ. Proc. § 580d). Since most residential foreclosures are nonjudicial, this means that most Californians going through foreclosure don't have to worry about being on the hook to the foreclosing lender for a deficiency judgment. However, if you have a second or third mortgage, or a HELOC, in certain circumstances you may face a lawsuit from one of those lenders (see below).
If the lender chooses to pursue a judicial foreclosure, deficiency judgments are allowed. To obtain the deficiency judgment, the lender must file an application with the court within three months of the foreclosure sale. The judge will then hold a fair value hearing to determine the fair value of the property. The deficiency judgment will be limited to the lesser of:
However, even if the lender uses judicial foreclosure, deficiency judgments are not allowed in cases where the loan was:
According to California's one action rule, the lender can only pursue one form of action for the recovery of a debt or mortgage. (Cal. Code Civ. Proc. § 726[a]). This means that a mortgage lender is only allowed to:
Security First Rule. The one action rule seemingly gives the lender the option to sue the borrower personally based on the promissory note and forego foreclosure. However, courts have interpreted the rule to mean that a lender must pursue the secured real estate first. This is known as the “security first rule”. This means the lender cannot sue on the promissory note as the first method of collection. (Cal. Code Civ. Proc. § 726(a)).
When a senior lienholder forecloses, any junior liens (these would include second mortgages and HELOCs, among others) are also foreclosed and those junior lienholders lose their security interest in the real estate. If a junior lienholder has been sold-out in this manner, that junior lienholder can sue the borrower personally on the promissory note. This means that if the equity in your home doesn’t cover second and third mortgages, you may face lawsuits from those lenders to collect the balance of the loans. There are some exceptions to this rule as well. For example, if the same lender holds both the senior and junior loan, the lender cannot pursue a personal judgment against you for the junior loan after foreclosing on the senior loan. Also, the lender cannot seek a personal judgment against you if the loan was a purchase-money loan.
Learn more in our article What Happens to Liens and Second Mortgages in Foreclosure?
A short sale is when you sell your home for less than the total debt balance remaining on your mortgage and the proceeds of the sale pay off a portion of the mortgage balance. (Learn more about short sales to avoid foreclosure.) California law does not permit a lender to obtain a deficiency judgment following the short sale of a residential property that contains not more than four units. Junior lienholders are also prohibited from pursuing a deficiency judgment if they have agreed to the short sale (Cal. Code Civ. Proc. § 580e).
A deed in lieu of foreclosure occurs when a lender agrees to accept a deed to the property instead of foreclosing in order to obtain title. (Learn more about deeds in lieu of foreclosure.) With a deed in lieu of foreclosure, the deficiency amount is the difference between the fair market value of the property and the total debt. To avoid a deficiency judgment with a deed in lieu of foreclosure, the agreement must expressly state that the transaction is in full satisfaction of the debt. If the deed in lieu of foreclosure agreement does not contain this provision, the lender may file a subsequent lawsuit to obtain a deficiency judgment.