If your home in California sells at a foreclosure sale for less than you owe on your mortgage loan, you might still be on the hook to pay more. That's because, under specific circumstances, California law allows the foreclosing bank to get a deficiency judgment for the difference between the sale price and the total mortgage debt.
Under most circumstances, however, California law prohibits deficiency judgments. Fortunately, the majority of foreclosed homeowners in California won't have to pay this kind of judgment.
In a foreclosure, the total debt that the borrower owes sometimes exceeds the foreclosure sale price. The difference between the total debt and the sale price is called a "deficiency."
In some states, the foreclosing bank can seek a personal judgment, called a "deficiency judgment," against the debtor to recover the deficiency. Generally, once the bank gets a deficiency judgment against you, the bank may collect this amount from your other assets or income.
In California, foreclosures can be either judicial or nonjudicial. Judicial foreclosures are administered through the state court system, while nonjudicial foreclosures have no court supervision, and a foreclosure trustee handles the process. Most residential foreclosures in California are nonjudicial.
Deficiency judgments aren't allowed after nonjudicial foreclosures. With judicial foreclosures, deficiency judgments are sometimes permitted.
A foreclosing bank can't get a deficiency judgment after a nonjudicial foreclosure in California. (Cal. Code Civ. Proc. § 580d).
Because most residential foreclosures are nonjudicial, Californians going through foreclosure usually don't have to worry about being on the hook to the foreclosing bank for a deficiency judgment. But if you have a second mortgage, you might face a lawsuit from that lender depending on the circumstances (see below).
If the bank chooses to pursue a judicial foreclosure, deficiency judgments are generally allowed.
To get the deficiency judgment, the bank has to file an application with the court within three months of the foreclosure sale.
The judge will hold a fair value hearing to determine the property's value. The deficiency judgment will be limited to the lesser of:
Say the total amount you owe on your home loan, including outstanding principal, interest, fees, and costs, is $700,000. Your home sells for $650,000 at a foreclosure sale. The deficiency is $50,000. But if the property's fair market value is $675,000, a deficiency judgment will be limited to $25,000.
Even if the bank uses a judicial foreclosure process, deficiency judgments aren't allowed in cases where the loan was:
California's one-action rule further limits a bank's ability to get a deficiency judgment. Under this rule, the bank can pursue only one form of action for the recovery of a debt or mortgage. (Cal. Code Civ. Proc. § 726(a)).
So, to collect a defaulted debt, the bank may:
While the one-action rule seemingly gives the bank the option to sue the borrower personally on the promissory note and forgo foreclosing, courts have interpreted the rule to mean that a bank must pursue the secured real estate first. Under this "security-first rule," the bank can't sue on the note as the first method of collection. (Cal. Code Civ. Proc. § 726(a)).
California law generally prohibits a deficiency judgment following the short sale of a residential property with no more than four units. Junior lienholders are also prohibited from pursuing a deficiency judgment if they agree to the short sale and they receive proceeds as agreed. (Cal. Code Civ. Proc. § 580e).
However, if you perpetrate fraud or commit waste with respect to the property (damage it), the bank can seek damages against you. Also, the anti-deficiency law doesn't apply to a borrower that is a corporation, LLC, limited partnership, or political subdivision of the state.
In addition, under California law, the bank can't require the borrower to pay any additional compensation, aside from the proceeds of the short sale, in exchange for giving written consent to the sale. So, the bank can't require the borrower to sign a promissory note or contribute funds at the close of escrow as a condition of the short sale. (Cal. Code Civ. Proc. § 580e).
A "deed in lieu of foreclosure" (deed in lieu) is when a bank agrees to accept a deed to the property instead of foreclosing. With a deed in lieu, the deficiency amount is the difference between the total debt and the property's fair market value.
Often, a deed in lieu is deemed to satisfy the debt fully. But California doesn't have a law that says the bank can't get a deficiency judgment following this kind of transaction. So, the bank might try to hold you liable for a deficiency following a deed in lieu.
To avoid a deficiency judgment, the agreement you sign must expressly state that the transaction completely satisfies the debt. If the deed in lieu contract doesn't contain this provision, the bank may file a lawsuit to obtain a deficiency judgment. But if the bank forgives the deficiency, you might have tax consequences.
Previously, under California law, if a bank or mortgage company held both senior and junior deeds of trust on a property, the holder was barred from suing to collect the deficiency on the "sold-out" junior debt after nonjudicially foreclosing the senior deed of trust. But the California Supreme Court's decision in Black Sky Capital, LLC v. Cobb potentially opens the door for banks and other entities to enforce two liens on the same property.
If a senior lienholder forecloses on your home, any junior liens—such as second mortgages, home equity loans, and HELOCs—are also foreclosed. This means that those junior lienholders lose their security interest in the property. In this kind of situation, the junior lienholders are called "sold-out junior lienholders."
For more than two decades, California courts followed the First District Court of Appeal's decision in Simon v. Superior Court, 4 Cal.App.4th 63 (1992). In that case, the court decided that if the same entity (like a mortgage company or bank) holds both a senior and junior loan on a property, that entity can't go after the borrowers for a deficiency judgment regarding the junior loan after foreclosing the senior.
But in June 2017, the Fourth District Court of Appeal disagreed with the decision in the Simon case. The Fourth District Court of Appeal held that California law (Cal. Code Civ. Proc. § 580d) doesn't prohibit a sold-out junior lienholder from suing the borrower for the deficiency after the nonjudicial foreclosure of the first lien—even in situations when the same entity holds both the senior and junior liens. (Black Sky Capital, LLC v. Cobb, 12 Cal.App.5th 887 (2017)).
Because the Courts of Appeal in the First and Fourth Districts interpreted Section 580d differently, the California Supreme Court agreed to hear the matter.
The California Supreme Court agreed with the Fourth District Court of Appeal. On May 6, 2019, the Court issued its finding, which determined when a bank or mortgage company holds two deeds of trust on the same property, the holder may seek a deficiency judgment on the extinguished junior lien.
While this decision expands lienholder deficiency rights in California, keep in mind that—even if you have two deeds of trust on your home that are held by the same entity—another anti-deficiency law might apply that would prohibit that bank from coming after you for a deficiency judgment on the junior lien.
Also, in the Black Sky case, the senior and junior loans were separated by a substantial time period. The court stated that "Where there is evidence of gamesmanship by the holder of senior and junior liens on the same property, a substantial question would arise whether the two liens held by the same creditor should...be treated as a single lien." In such circumstances, the anti-deficiency protection of Section 580d might apply.
So, if a lender made both loans concurrently, essentially treating one loan as two (perhaps in order to recover under the junior loan what it couldn't recover if it had issued a single loan on the same property), then the outcome of such a case could be different.
If you're a California homeowner facing a foreclosure and want to learn about any defenses you may have or about different ways to avoid a foreclosure, consider talking to an attorney.
A HUD-approved housing counselor can tell you about foreclosure avoidance options at no cost if you can't afford an attorney.