One of the most common questions we are asked, is after a short sale or foreclosure in California can the lender attach bank accounts or other assets to make up for the shortage.

The answer in almost every situation is no, however, in some instances you can't just walk away from your home.

California has a variety of laws designed to protect homeowners in the event of default.  One of these rules is called the "one action rule".  The one action rule says quite simply that the lender must decide how they wish to foreclose, either through trustees sale, called non-judicial foreclosure or through law suit, called judicial foreclosure.  They can't do both.

If the lender pursues a trustees sale and forecloses on the property all the lender gets is the property.  California law prohibits them from pursuing a deficiency against the borrower.  However, if there are junior liens, a second trust deed or credit line, the borrower may still have some liability after a foreclosure to the junior lien holder/s.  If junior liens do not participate in the foreclosure and lose their collateral through foreclosure in some instances they may be able to perfect the lien after the trustees sale.

If the money owed was used to purchase the property and it is residential property, defined as one to four units, it is considered non-recourse.  This means that no matter whether or not the junior lien holder participates in the trustees sale they are not entitled to anything else and could not pursue a deficiency judgment against the borrower.

However, if a borrower has refinanced the loan or taken out a line of credit after purchasing the home, this financing is now considered to be recourse financing.  This means junior lien holders may have the ability to perfect their lien after foreclosure.  To do so it appears as if they must commence an action in court within 90 days of the trustees sale and then prevail in court in order for the debt to continue to exist.

If a borrower on a residential property asks the lender to participate in a '"short payoff" or short sale, and the lender agrees, under current California law the lender can't pursue any other action against the seller.  The lender, no matter what position they are in, first, second, third etc. are prohibited from obtaining or collecting a deficiency from the borrower after the short sale has closed.  Emergency legislation signed by the Governor on July 15, 2011, made it illegal to require the borrower to bring additional funds to the table as condition of approving the short sale.

Senate Bill 931 which took effect on January 1, 2011 protected borrowers in short sale from the first mortgage and Senate Bill 438 which took effect on July 15, 2011 protected the borrowers from all junior liens as well.  With the passage of these two California Association of Realtor sponsored bills most borrowers who complete a short sale can be assured that there will be no further action taken against them by the lender, unless they engaged in fraud.

Notice - California Real Estate Brokers can't provide legal advice.  This is not meant as a legal opinion.  Any borrower considering short sale or facing foreclosure should consult their legal advisor and tax professional for advice.

Short Sale

Selling a home for market value and having the lender take less than is owed is called a "Short Pay" or "Short Sale". Although each lender handles them a little different the process is very similar with all lenders. In a short sale the borrower markets the property and obtains an offer at current market value. The lender agrees to take the net proceeds after deducting the normal costs of sale, including real estate commissions, even if it is less than is owed on the property.

Typical Rules to Qualify for a Short Sale

The borrower must be at least 30 days late making their scheduled payments.  Several Lenders have now changed this to 60 days late.

The borrower must demonstrate a hardship. Hardships include, divorce, change of job, change of income, change of family size, job transfer, recent medical bills. (Bank of America is testing a pilot program in which the borrower does not have to provide any documents and can be paid up to $2,500 as long as the bank gets the net proceeds they have predetermined by appraisal).

The property must be sold for current market value. The lender will get an appraisal and have local Brokers provide a price opinion.

The property can't be sold to an immediate family member or controlled business interest. It must be an "arms length" transaction.

The borrower must maintain the property until the close of escrow.

A short sale can have tax implications. The lender may give you a 1099 for the difference between what was owed and what the lender received. For example, if you owe $210,000 and the net proceeds from the sale are $170,000 you may have to report $40,000 in income on your state and federal tax returns. IRS tax code says that if the borrower is insolvent at the time of sale that they do not have to report the income.  The Mortgage and Debt Relief Act of 2007, signed in December of 2007, generally allows the short sale of your principal residence without tax consequences as long as the total value is under $2 million dollars.  If the loan is a purchase money loan for residential property and therefore non-recourse IRS Revenue Code states that in short sale you report the sales price as the amount owed, not the amount the lender realized and therefore generally would not have to report the amount on the 1099 as ordinary income.

In California two new laws, SB 931 which took effect on January 1, 2011 and SB 438 which took effect on July 15, 2011 do not allow a lender to obtain a deficiency judgement on residential property if they particiapted in a short sale.  They further prohibit the lender from requiring additional payments or notes from the seller as a condition of approving the short sale.  They must accept the proceeds from the short sale as payment in full for the debt owed.

If you would like a free consultation regarding the value of your property and whether or not you are a candidate for a short sale, refinance or traditional sale contact Realty Stars for a no obligation appointment.  559-732-4444