Short Sale Deficiency Judgments Limited

Prior to 2011, only those borrowers with purchase money loans on their homes had

the privilege of utilizing the short sale process to sell their properties without worry of a lender seeking to obtain deficiency judgments against them sometime in the future. However, as of January 1, 2011, those who have refinanced their home loans will also be able to take advantage of a short sale without fear that their lender will someday file a deficiency judgment action seeking damages for the unpaid balance of the loan.

This remarkable opportunity became available when California Senate Bill 931 was passed by the California State Legislature and signed into law on September 30, 2010. Senate Bill 931 adds section 580(e) to the California Code of Civil Procedure. This new Section 580(e) prohibits a lender holding a first deed of trust for a residential property from demanding a deficiency judgment from the owner/borrower who sells the property for less than the remaining amount of the indebtedness due at the time of the short sale.

Homeowners with purchase money loans, which are loans obtained at the time a property is purchased, have been the only borrowers in recent years able to discharge the unpaid balances of their loans via a short sale without risk of a deficiency judgment. The key aspect of this new law is that the many homeowners who understandably took advantage of the historically low interest rates offered in the last decade by refinancing may now also avail themselves of the option to sell their homes short of the total balance owed on their homes without fear of potential legal action by their lenders.

This law does not just apply to owner-occupied properties. Investors that own one-to-four unit residential rental properties may also sell these properties for less than the total loan balance owned without fear of legal recourse.

The economic impact of this new law has the potential to be tremendous. Multitudes of property owners with refinanced loan balances that exceed market values will now be able sell their homes and move into more affordable accommodations. This is likely to create a surge in home sales that could provide a much needed boost for the real estate, construction and lending industries. This new alternative for borrowers will also help reduce the number of foreclosures and thereby lessen their negative effect on property values.

It is important to note that only holders of first deeds of trust are prohibited from obtaining deficiency judgments after a short sale. So borrower-owners with re-financed second loans against their homes are not totally protected by this new law. This change also only applies to short sales in California that close escrow after January 1, 2011.

by: Brian S. Icenhower

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