A deficiency judgment is the assessment of personal liability against the seller for the unpaid balance of the mortgage debt when the proceeds of a foreclosure or short sale are insufficient to satisfy the debt. Such liability is typically crushing for a seller who in all likelihood is already facing financial difficulties. Therefore, any seller considering the short sale option or facing foreclosure must examine the potential for a deficiency judgment. California addresses this issue within CA Code of Civil Procedure section 580, et seq.
The crucial determination is whether the loan at issue is considered “recourse” or “non-recourse” debt. See the below definitions:
In the event of default by the borrower, the lender is restricted to recovering the property, without any right to proceed against the borrower for any deficiency after sale. The lender is prohibited from seeking any of the borrower’s assets separate from the subject property. Of course, if any fraud, misrepresentation or other illegal acts are discovered on the part of the borrower, exceptions will apply.
In California, debt is treated as “non-recourse” under the following two loan scenarios:
1) when loan is made to purchase residential dwelling of four units or less, where borrower occupies at least one unit; OR
2) any seller carry back financing secured by subject property.
In the event of default by the borrower, the borrower may be personally liable for the deficiency and the lender may choose to reach to the borrower’s personal assets such as bank accounts, wages, and any other assets the lender can locate.
Examples of recourse loans are refinancing of existing loans, commercial property loans, or H.E.L.O.C. loans.
Determining whether you may face a deficiency judgment as a result of a potential short sale or foreclosure is an essential analysis. Of course, there are a variety of other important considerations such as potential tax consequences and effects on credit ratings.