Non-Recourse Loans: The California Anti-Deficiency Statute and Foreclosure

For many borrowers, the choice of whether to file bankruptcy depends on a determination of whether a home-owner will be liable for debt on his home following foreclosure.

California has enacted a very strong law protecting home-owners from deficiency judgments following a foreclosure.  This is called the anti-deficiency statute or non-recourse statute.  It says, in sum, that borrowers who take:

   1. purchase money loans
   2. on an owner-occupied residence

are not liable to the lender for deficiencies following a non-judicial foreclosure.  There is a lot to unpack in that statement.  Let us look deeper into the California anti-deficiency statute piece by piece:

Purchase Money

A loan is purchase money when all of the money taken out by the loan was used to purchase the home. This is generally met in first mortgages.  Some second mortgages qualify as purchase money, generally when they were taken at the same time as the first.  In some cases, refinances will maintain the purchase money character, but an examination into the terms of the refinanced loan is necessary.

Loans that are never purchase money include home equity lines of credit (HELOCs), refinances where the borrower takes hard money out of the house, debt consolidation loans, home improvement loans, etc.

Owner-Occupied Residence

To be non-recourse the loan in question must be secured by an owner-occupied dwelling of no more than 4 units.  That means you have to have lived in the property secured by the loan.  The residence requirements are not particularly spelled out, but the requirement is intended to root out the real estate investor.

Non-judicial Foreclosure

There are two types of foreclosure in California: judicial and non-judicial.  By far the most common foreclosures are non-judicial.  Non-judicial foreclosure are much less expensive, faster, and do not require a judge's approval.  The non-recourse statute only protects borrowers from non-judicial foreclosures, but almost all foreclosures in California are non-judicial.

Non-Recourse: What does it mean?

If your loan is non-recourse, it means that upon foreclosure the only thing that the home lender can recover from you is the property itself.  The loan will be considered satisfied by the foreclosure sale, regardless of the price that the home fetches.  The lender cannot sue you for the deficiency (the amount that you are upside down on the house) or take other collection actions against you. 

The non-recourse statute does not necessarily protect you from intentional damage that you do to the home, however, as other causes of action may arrive from trashing the house or stripping the copper piping.  So avoid damaging the house on your way out.

Deficiency

Finally, it is important to remember the difference between being liable for a deficiency on a loan is different that incurring cash liability.  This article deals with debt liability--whether the lender can sue the borrower for cash after the foreclosure--as opposed to tax liability.  In almost all foreclosures the lender will send the borrower a 1099 after the trustee's sale or short sale.  There are many defenses to the 1099 including insolvency, various state and federal homeowner's tax relief acts, and capital gains tax laws.  These defenses are not explored in detail in this article.

Deficiency would result in collection action and potentially a law suit and judgment resulting in wage garnishment, liens on future property, or levies of bank accounts.