Thursday, November 26, 2009

Can lender come after the Borrower for deficiency in a foreclosure?

Most people think that their liability is limited by the security interest and if property is foreclosed they are not liable. This articles intends to clarify the (mis)understanding.
The answer is- depends. It is not a lawyer like answer. The answer really depends on whether the loan the lender had given on the property being foreclosed was a purchase money loan or a refinance loan.

If the loan the lender had given against the property was a purchase money loan, the anti-deficiency laws prevent the lender from being able to file a lawsuit for the deficiency.

However, if the loan the lender had given against the property was a refinance loan, the anti-deficiency laws allow the lender to file a lawsuit for the deficiency.

The logic is that in a refinanced loan, the borrower was able to find better loan terms or perhaps took the equity out and used it to his or her benefit. So, there is a presumption of added benefit thus allowing lenders to recover the deficiency amount.

The deficiency amount is the difference between the loan amount and amount of money recovered by the lender after foreclosure.

Purchase money loan is the original loan obtained by the borrower at the time of purchase of the property.

Refinance loan is the loan obtained by refinancing the loan to get better loan terms (interest rate, amortization period, etc.) or to take cash out for personal use or to pay off other debts.

Lot of people bought the property to get their foot in the door and got a low interest rate, mostly negative amortization loan. Later, they refinanced the loan when the property went up in value. It was easier. Lenders did not care because it is profitable business. Lenders, loan brokers, appraisers, escrow companies-everybody made money. Now, these people, if facing foreclosure, can be liable for the deficiency amount.

Lot of people know about One Action Rule and think that lender can not bring claim for deficiency. One Action rule is provision of law under California Code of Civil Procedure. Basically, it forces a lender to choose between foreclosure and judicial action which combines foreclosure and deficiency judgment. So, as the name suggest, lender has to decide which (one) form the lender will chose.

The primary method of foreclosure in California involves what is known as non-judicial foreclosure. This type of foreclosure does not involve court action. If a foreclosure is completed by non-judicial means, a second action to recover a deficiency judgment is not permitted. However, rules stated above apply under the case law that if the loan is refinance loan, the deficiency action can be brought. Most lenders will negotiate the amount though and settle for less. This can be an opportunity to negotiate the debt down.