Picture this scenario: In 1991 you buy a $200,000 house with 10% down and obtain a $180,000 first trust deed from XYZ Bank. By 1994 the real estate market is depressed and the house is now worth $140,000. In the interim period, you have lost your job and your credit is terrible. You stop making payments on the house because it isn’t even worth the amount of the mortgage. You offer to "give" the property back to the bank with a "Deed in Lieu of Foreclosure." The bank refuses and states that you owe them $180,000 plus back interest and they intend to sue you for that money. Are you now faced with losing your house AND owing the bank money for the deficiency, i.e. the difference between what you owe and the eventual bank resale of the property? Unfortunately, this was a question that thousands of people asked themselves during the mid 1990’s.

Fortunately for the California homeowner, we have anti-deficiency statutes which cover loans used to PURCHASE owner occupied single family homes, condominiums and 1-4 unit residential properties. The bank can bluster all they want, but the only thing they can do is take back the property and blemish your credit. This threat of lawsuit usually comes when a local bank originated the loan and then sold it to an out of state mortgage company. If the loan is serviced or owned by an out of town mortgage company, the loan servicing agent making idle threats may not be familiar with California law or, worse, they may realize that they have no teeth but try to "buffalo" you anyway. These anti-deficiency statutes were purposely enacted to make certain that California homeowners do not lose their house AND face a legal hassle and large judgment. This is a balance of the rights of the lender versus homeowner devastation.

Just to be clear, let me restate: If you are an owner occupant of a condominium, single family residence or 1-4 residential units and your existing loan or loans were used to PURCHASE the property, the ONLY option your lender has is to foreclose on the property. You have no legal obligation to pay back the loan. Remember, this only covers loans used to PURCHASE the above referenced property. If you refinanced this property, the lender DOES have the right to file a JUDICIAL foreclosure and sue for a deficiency. Having said that, however, let me tell you that it is EXTREMELY RARE for lenders to use this remedy on a homeowner occupied property even if it is legally available to them. The vast, vast majority of California foreclosures are non-judicial.

Regardless of the comfort that I intended to give California homeowners reading this article, do not take threats of judicial foreclosure lightly. If your lender is threatening to file a judicial foreclosure, see a real estate attorney immediately. If nothing else, the attorney can write a letter to the bank and tell them bluntly to "go away and stop harassing my client."

Deficiency judgment protection in California is extended to other types of loans and other loan circumstances. This is a very complex area and I don’t have space here to try to explain the details. Let me just say that "seller carry-backs" are also no-deficiency judgment loans, even if the property is commercial, land, etc. Again, a real estate attorney can easily guide you through the deficiency judgment minefield.

Now that I have given you the good news, don’t think that this statute protects "bad people." Unfortunately, many loans are made based on borrower fraud. If the buyer’s loan application is a complete fabrication, don’t rely on the above referenced state statutes to protect you. There are ample federal statutes that will allow the lender to "eat you up and spit you out" if your application was fabricated. It is unfortunate that there are some real estate agents, mortgage brokers and CPA’s who think nothing of helping a buyer "qualify" for a loan they don’t qualify for. This practice was widespread in the 1980’s and was drastically curtailed in the 1990’s following many arrests and prosecutions by the federal government (felony). If you have heard the expression "you don’t need to make a federal case of this," the FBI did just that. Not only is it a federal felony to defraud a federally regulated bank or loan institution by use of a fraudulent application, it is also a major felony to assist the buyer in that fraud. Conspiracy to defraud a federal lender is no laughing matter.

I often advise against putting 5-10% down on a property, as the hidden costs of "low money down" loans can be expensive. Higher rates and private mortgage insurance (PMI) are just a start. A very small down payment does have one great advantage as you can see from this article. If property values drop substantially, a homeowner occupant with the above described property only stands to lose that small down payment.

The bottom line here is that I am an optimist and the real estate market looks rosy and larger down payments equal better loans.

Peter Rosenthal
VIP Trust Deed Company