The California residential real estate blogs and media have been enjoying an anti-deficiency “happy dance” the last several days. Is this warranted or will some homeowners suffer unintended consequences by the expansion of the anti-deficiency provisions of CCP 580e to junior liens? In the short term, certainly many lenders will.
Existing Law
In late 2010 the California Legislature adopted, and the Governor signed, a bill creating Section 580e of the Code of Civil Procedure. This new section provided essentially that when a holder of a first deed of trust encumbering a 1–4 unit dwelling approves a short sale that is paid according to its terms then the holder (beneficiary) cannot subsequently pursue any form of deficiency liability against the borrower except in limited exceptions (which will be discussed below).
New Law
Last month the Legislature approved SB 458 (SB stands for “Senate Bill”). The Governor signed it as an “urgency measure” on July 11. It was filed with the Secretary of State on July 15, 2011. Most laws are effective on January 1 in the year after they are adopted. An urgency measure requires a super-majority vote and goes into effect immediately. Hence, it is currently effective for all short sales that meet its criteria. (Registered readers can receive a PDF copy of the official version of the new law by opening the preceding article.)
The new law expands the applicable rule to holders of notes secured by deed of trust or mortgage solely encumbering a 1–4 unit dwelling regardless of the priority of the deed of trust or mortgage (the “lien”). Therefore, it applies to second, third and subsequent deeds of trust, including HELOC’s (home equity lines of credit). It does NOT apply if the borrower (technically the trustor or mortgagor) is a corporation, limited liability company, limited partnership or political subdivision of the state, nor to deeds of trust securing bonds, such as public utility bonds.
Prior to 2011 a primary anti-deficiency rule applied primarily to purchase money deeds of trusts encumbering 1–4 unit dwellings that were occupied by the borrower (at least at the origination of the loan). The broader new law applied to vacation homes, rental properties, cash-out refinances, and HELOC’s, among others. It also does not fully apply when one loan is secured by more than one parcel of property, what is often called a cross-collateralized loan.
A short sale works only when all lien holders approve; otherwise, the non-approving lien(s) remains against the property in the full amount of the balance of the applicable debt. For practical purposes, this does not happen. The short sale is only complete, and the new law only applies, when title “has been voluntarily transferred to a buyer by grant deed or by other document of conveyance that has been recorded . . .” There must have been written consent by the holder of the note for which the procees of sale have been tendered to the note beneficiaries in accordance with the parties’ agreement (the short payoff letter terms).
Benefits
The primary benefit of the expanded law is that, “No deficiency shall be owed or collected, and no deficiency judgment shall be requested or rendered for any deficiency upon a note secured solely by a deed of trust . . .”
In addition, the law provides that a holder of a note shall not require the borrower “to pay any additional compensation, aside from the proceeds of the sale, in exchange for the written consent of the sale.” Hence, new notes from the borrower and “seller contribution” payments cannot be required.
Finally, any purported waiver “shall be void and against public policy.” So even if a lender gets a borrower to sign a waiver of the new law, that waiver is void and cannot be enforced.
Further Exceptions
The new law does not apply if the borrower commits fraud with respect to the short sale. Essentially, if the borrower/seller lies on their short sale application, then their short sale is subject to the laws applicable without this statute. Therefore, a “strategic default” application apparently must disclose the intentional nature of the breach and cannot argue a false hardship.
Another exception applies if the borrower commits waste with respect to the property. “Waste” is essentially intentional or grossly negligent damage to the property. So the seller/borrower cannot rip out appliances, smash windows or holes in walls, ignore leaking roofs, pour cement down the toilets, or similar damages to the property. In those cases, the “holder of the deed of trust or mortgage” is not limited in their ability to seek damages against the borrower. (Ordinarily, the references are to a “holder” of the promissory note who is the “beneficiary” of the deed of trust. It will be interesting to see if any talented litigation attorney can exploit this phrasing.)
Unexpected Benefit or Cancellation?
As an urgency measure, SB 458 applies immediately. This means that outstanding short sale approvals are subject to the new law. If the lenders do not respond otherwise, an existing short sale approval which requires the seller to contribute cash in addition to sale proceeds or to execute a promissory note for all or part of the short sale cannot have those terms enforced. However, the non-deficiency provision is subject to a sale “in accordance with the written consent” of the lender. By not making the cash contribution or nor submitting the promissory note, the terms of the written consent have not been met and the new law does not appear to apply.
If the junior lien holder did not require a cash contribution or a promissory note, then no deficiency applies – which may not be what the junior lien holder intended. In those cases, the borrower enjoys an unexpected benefit. If the lien holder realizes this before closing, the lien holder might withdraw or cancel the approval and then demand higher payment since it’s potential for a deficiency judgment is gone.
Primary Unintended Consequence
All the commentators who thought they were enjoying a “happy dance” might find that they were actually doing a “rain dance” and the banks will rain on their parade. The published committee reports say that the banking industry supported SB 458. That implies that they don’t expect the new law to impact their returns. How could that be?
A short sale requires the approval of all lien holders. Otherwise, the non-approving lien holder will not release their mortgage against the property and the transaction fails because the buyer is understandably unwilling to close.
For example, let’s assume a property with a $400,000 first deed of trust from a cash out re-fi and a $150,000 HELOC secured by a second deed of trust for a property that would sell in a non-distress sale for $400,000 as if it was free and clear. Under pre-2011 law, the seller could be subject to deficiency liability from both loans.
Let’s assume a very small distress sale discount of 10%. The market would be willing to pay $360,000 (90% of $400,000). Let’s assume the first lien holder approves closing costs and commissions totaling 7% or $25,200 and a $4,500 payment to the second (who would get nothing in a foreclosure) based on the lower of $5,000 or 3% of the loan. This leaves the first with $330,300 net proceeds on a $400,000 note. The first would be getting 82.575% of their note balance, which is probably enough for them to release the seller from deficiency liability in advance.
However, the holder of the HELOC refuses to approve the short sale without some combination of cash and note for $15,000 (10%) in order to release it’s lien or of $22,500 (15%) to also release liability. Now the first counter-offers by saying it will allow a $5,000 payment and not object to a $10,000 note. The seller is thinking they won’t approve a mere release of lien and can’t pay the extra $7,500. The buyer decides he is willing to contribute $7,500 toward the settlement since the gross outlay would be $367,500 for a property that should carry a non-distressed price of $400,000 and a deal is assembled in which the seller has all deficiency waived due to creative structuring, while agreeing to only a $10,000 future liability.
Now, fast forward to the adoption of SB 458 and the newly amended version of CCP 580e. The first trust deed holder approves a $360,000 sales price, 7% combined closing costs and commission, with a $4,500 payment to the second. The second demands $22,500 because that’s it’s 15% threshold to release a borrower from liability.
[Portions below revised from original at 10:15 a.m. PDT July 19, 2011.]
This increased demand can now only be accomplished by the first trust deed holder accepting lower net proceeds because the new law prohibits the seller giving the note to the second lien holder and the buyer from making a contribution to the second. However, the first is unwilling to accept only $312,300, which is only 78.075% of its note balance – an level which in this example fails to meet the note holders standard for short sale vs. foreclosure.
At this point, the first trust deed holder estimates that they could get close to $312,300, which represents about a 22% discount off the estimated market price of $400,000 – an amount which is in line with the foreclosure auction discount rate – AND still have the potential for a higher return if the property becomes an REO and is maintained and marketed effectively.
The new result of this hypothetical is that the short sale fails, the property goes to foreclosure, and the seller is subject to the risks of deficiency liability for the full amount of the HELOC.
The new law has put the hypothetical seller in a far worse position and caused a foreclosure that would have been avoided under present law.
CONCLUSION
I think the adoption of SB 458 as an urgency measure which became effective immediately, without time for the market planning to absorb its impact will have two unintended consequences:
1. Pending short sale approvals in which a junior lien holder had agreed to the short sale subject to an additional cash payment or a promissory note may very likely be withdrawn and new terms must be negotiated. The new dynamics may result in those short sales converting to foreclosures.
2. New and ongoing short sale negotiations in which a junior lien holder holds a higher value note, such as more than $50,000, will be less likely to approve short sales because they will be unable to meet their liability waiver thresholds via the low level of payments approved by the first trust deed holder. This will force the first to foreclose due to non-approval by the second, resulting in the borrower’s potential deficiency liability for the full amount of the second, rather than a lower agreed amount under the old method. Plus the seller has a foreclosure on record which would have been avoided under the old law.
IF YOU KNOW OF A SHORT SALE APPROVAL THAT HAS BEEN AFFECTED BY THE ADOPTION OF SB 458, PLEASE POST A COMMENT ABOUT IT BELOW.
I m not sure if I understand this correctly, Does this mean that once a short sale is completed, the sellers will not have any more liabilities,they can just walk away?
Thanks for the analysis Ron.
Well… like most things it depends on the assumptions we choose which become the foundation of the scenario and (likely) outcomes.
1. Pending short sales – I can see how many 2nd lien holders may re-negotiate terms. Be interesting to see how many “catch” the new law changes and, if they do, simply just let the deals go through anyway since the approvals have already been issued.
2. Foreclosure and liability on 1-4 unit, owner-occ: Even though CA’s “anti-deficiency” language for foreclosure is explicitly only “purchase money deeds of trust”, are not borrowers still protected by the “1 action rule” with CA NON-judicial foreclosure action? In other words, unless foreclosing lender initiates a judicial foreclosure (very rare in CA) then lender cannot obtain a deficiency judgment? They foreclosed on the courthouse steps, got the collateral back, used their “1 action”, and that’s it? Now junior position liens are “wiped out” (from title) in that 1st lien foreclosure sale, but they didn’t foreclose, hence didn’t use their “1 action”, and therefore are still free to pursue deficiency/collection on a now-unsecured debt?
3. “Foreclosure auction discount rate” above: That number in your scenario here ($312,300) might be in line with auction discount rate, but the question is will there be a 3rd party cash investor who will pay that amount at the steps therefore the lender getting out close to that $312,300 number NET?? Since my local auctions consistently show only a 2-4% 3rd party investor participation rate on any given sale day (current breakdown is approx: 80%+ postponed, 5-10% cancelled, 10-12% REO), it’s quite likely the lender won’t dispose of the property at just that 22% auction discount… or even dispose of it at all at sale.
Now we’re off to the races: Lender now becomes owner of record, but wait:
a. Likely unpaid back prop taxes (with penalties) have to be paid
b. Occupants in property (at least 90 days; possibly longer with u/d and attendant atty costs)
c. Holding costs – taxes, ins, possible HOA
d. Prop preservation costs; possible blight liens by local gov
e. Possible vandalism/theft
f. Possible rehab costs (to increase curb appeal; trying to get highest FMV)
g. Possible realized loan loss write-down to market; capital reserves issues?
In short: less NET & more LIABILITY to the lender to foreclose than short sale (even with new 580e). Of course, we’ve been making this basic argument for years towards lenders and they still foreclose, spend more money with more liability, and end up selling the REO for less than our short sale offer 9 months earlier. And the CoreLoser comes out with their alarmist report about how much $ lenders are “losing” to “short sale fraud”. So I guess it’s still stupid is as stupid does with the basic premise of: this short sale offer is better than REO you dummy lender.
Anyway, just a few thoughts.
Figured a good post deserved some interaction and input… let you know we’re out here; reading and thinking about what you said.
Kinda OT here….
Re: Extend & Pretend
In my previous post I mentioned the high number of postponements in daily trustee sale figures.
Curious to hear other’s thoughts on why scheduled sales are constantly being postponed month after month after month….
My 2 cents:
1. Lenders simply don’t want liability of being actual owner of record and the attendant costs. It’s cheaper to just let the loan linger in default and foreclosure?
2. Some say lenders are doing this to “regulate” flow of REOs onto marketplace. This is happening (BoA is at 22-month REO inventory lows, another asset mgr has gone from 28,000 assets last year to 5900 currently, etc), but I don’t think it’s intentional on their part.
3. Some residual delays from the Robo-signing scandal, et al.
4. This one isn’t talked about much… but I wonder if a big (or biggest) factor is simply the way lenders do their accounting. From what I know, the lenders can keep all these defaulted loans on their books at face value… and even report the payments they are NOT getting as “deferred income”!! Until they actually finish foreclosure, they can keep these loans “marked to model” (as opposed to “marked to market”) and can even show income from the payments they are not receiving! This would seem to create a great incentive to do nothing, perhaps waiting for the “market to turnaround” or the next big “initiative” (ie gov to corp welfare handouts). And then, as a natural result, the “slowly leaking” properties onto the market flows out of that.
Eeeehhh… who knows??
I equally agree with the posting above from “CA Foreclosure Alternatives”.
I’m not sure how this is having the seller subject to risks of deficiency liability for BOTH loans? Unless you are just referring to the out clause of “Fraud and Waste”. or I’m I missing something here. Without Fraud and Waste then no recourse, great..
Some of these 2nds already know what they are up against with Fannie and Freddie’s limits to 2nds. Remember many of these 2nds have already been bought out and discounted. They have less skin in the game already.
I’m still shocked it passed.
I DON’T LIKE THE FLOATING SHARE BOX ON LEFT SIDE OF BLOG… ANNOYING. NEEDS TO HAVE OPTION TO CLOSE OR PLACED FURTHER AWAY FROM BLOG MARGIN.
Since this whole mess originated at systematic flaws of the Big Banks failing at Due Diligence, then I feel they should face consequences being the Government is waiving their jail sentences, sweeping the housing crisis under the carpet. They can lose the Diff’ of deficiencies. Short Sales is the way to go and should’ve been for past 2 years creating lesser REO /Foreclosure market,& values would’ve been kept @ higher levels.
The “holder of the deed of trust or mortgage” is not limited in their ability to seek damages against the borrower.
How many upside down homeowners leave the property in a condition NOT needing some rehab or can prove after the fact the vandalism latter found was none of their doing when bank leaves it vacant while processing for REO? And with the multiple postponements, bank has yet to own property so distressed homeowner still needs to keep insurance paid lest some liability or storm disaster does further damages to assign homeowner.
Also,If you purchased your house using the $8,000 tax credit, and you are now having problem maintaining payments, beware of the thought of renting or selling before 3 years, you will be required to pay it back! An added ouch!
Debt Resolution4U has done some deep thinking.Always another underlying repercussion if not thought through.
@Cal-Foreclosure Alt – touche – good rub! We got to keep plugging on the reality of it all!
Who was doing the ‘happy dance’?
Prior to the governor signing this bill, there was NO MENTION of the bill at car.org on the home page, not even on the legal or government affairs tabs.
Sharp analysis Ron!
Hi again. 🙂
I think I was falling asleep last nigh (because of the hour, not the content).
One fo the last things you wrote was’..less NET & more LIABILITY to the lender to foreclose than short sale’.
Have we discussed the concept that mostly there is no lender?
There is an investor, who will definitely receive less Net. And there is a servicer, who based on actions, seems to favor foreclosure, which hopefully becomes REO rather than being sold to a 3rd party, because in complete disregard of their fiduciary duty to the investor, they are only interested in their servicing fees and ancillary revenues from their affiliated vendors. A successful short sale cuts off that revenue stream.
I dare you to call me cynical. 🙂
Thank you everyone for the very thoughtful comments!
Honestly and objectively, I don’t think any other blog I’ve seen attracts such depth.
I mis-spoke in a portion or two of the original draft regarding liability to first lienholders in foreclosure. It is not good to write at 2AM and then not re-read. I was applying tax liability analysis to deficiency comments and other tired thinking. I revised and updated that as you can see, partly thanks to Attorney friend Paul Horn who shot me a text early on.
The sense of the comments overall to me is that the surface assumptions of the impact of the new law would be that borrowers would get the same deals they have been getting just without a promissory note or a demand for cash payment. The entrepreneurs and professionals commenting above understand the fallacy in that expectation and have added several additional insights of likely unintended consequences.
It will all be very fact sensitive as to what each deal is, what the borrower’s financials are, who the servicer is (and what their agenda is) and who the note holder is — along with what mortgage insurance issues and FDIC/TARP loss limiation terms are in place.
I particlular look forward to hearing about how deals are affected and if the new law ends up hindering rather than helping due to the elimination of important negotiation tools that had been available for dealing with junior lienholders.
Keep up the high level-conversation — even when you discuss my points that need clarification or correction.
Great comments from all! I’ve learned a lot of good info. I’m still involved in a Lis Pendens case, filed in Orange County (my home and current residence is in Santa Clara County) in early Feb 2011. You can read more at my WordPress blog (June 25 posting) here: http://kenpaar.wordpress.com/.
The holder of the promissory note is the authority to foreclose, short sale, loan mod, etc and we have no clue who they are since they did NOT use county recorder for these troubled loans. Now I am aware the servicers are sending letters advising homeowners to “validate the Debt” owed. If the homeowner does not dispute the debt within 30 days of receipt of the letter, it will be presumed valid under the provisions of the Fair Debt Collection Act. This is another maneuver around the note requirement as Ron pointed out. That is their next focus of attack, making the servicer the authority and removing the “club tools of a forensic audit ” and the regulations we use to get any deal with the banks.
If Then, public does not follow the instructions in the letter to send written notice to the servicer that you dispute the debt (and of course send certified mail, return receipt requested), by default the servicer becomes the authority, not the investor. Instead of proving the debt (most original notes were destroyed) with the note in court, they shift burden to homeowner failed to deny the debt, given the opportunity. Unintended consequences of this legislation steamrolling over our rights to solve problems generated by wall street improper .”securitization” of debt.
DebtResolution4U,
Interesting way to twist the FDCPA to screw the consumers it was supposedly intended to help. I need to update my research, but my recollection is that the FDCPA allows the consumer to demand to know the true creditor/holder of the debt. A couple years agi when I made a demand in connection with a loan mod (when borrowers were allowed to have attorneys assist them on equal footing with banks who have attorneys), the servicing bank said “we don’t have to follow that rule” our servicing agreement controls what we do. It was an amazingly blatant statement of the banking mentality that they are above the law.
Ron
I have read in other blogs that the new law does not prohibit other parties from contributing to the debt holder to get the short sale approved. I do not see anything in the wording of the law that says the buyer, or real estate agents can not make a contribution. This seems to me that there will be more pressure for agents to contribute part of their commissions to do the deal. In addition, can not the borrower choose to make a “voluntary” payment to induce approval of the short sale. The law only says that the lender can not require it for approval.
I agree that this new law will probably lead to fewer short sales being completed, because junior lien holders will decide that they can recover more money by letting the senior lender foreclose and then pursue a settlement from the borrower on their deficiency judgment.
Re; Finally, any purported waiver “shall be void and against public policy.” So even if a lender gets a borrower to sign a waiver of the new law, that waiver is void and cannot be enforced.
So, if a junior lien holder places a “deficiency acknowledgment” indicating that they have agreed to accept a sum of money only to release the deed of trust and not as a settlement in full of the underlying indebtedness…AND indicate that by signing the seller understands they are still liable for the remaining balance, this is voided according to the new law? Have a seller that is closing on 8/19 with this language still appearing despite SB 458. Junior lien holder may not be informed of the law….and I do not believe it’s our responsibility to inform them?
Sir,
The text of AB 458 as I found it online includes this statement:
“A holder of a note shall not require the trustor, mortgagor, or maker of the note to pay any additional compensation, aside from the proceeds of the sale, in exchange for the written consent to the sale.”
Your discussion of potential unforseen consequences includes this comment: [The] increased demand [of the second] can now only be accomplished by the first trust deed holder accepting lower net proceeds because the new law prohibits the seller giving the note to the second lien holder and the buyer from making a contribution to the second.”
In my quick review of AB 458, I saw no language that barred the buyer from making a contribution to the second, especially if done through the short-sale escrow. Even if the law includes such a bar, the buyer could simply increase his offer to cover the increased amount of the desired payment to the second. Of course, the price to the buyer would then be higher than in your hypothetical. Have I missed something that bars the buyer from contributing directly to the second?
Thanks,
TK
Yeomah, correct. Any verbiage that accepts or affirms a deficiency is void and the protection of the law cannot be waived. There is no duty to arm an adversary with information that might harm one.
bmegowan and tom keegan, good refinements in your comments. It does appear that the buyer and agents could kick-in additional consideration — and may now be pressured even more to do so. Merely increasing the purchase price usually doesn’t work in the feedback I receive: the first then wants the increased net. The additional consideration needs to show on the buyer’s side of the HUD-1 or be made as an independent aspect of debt settlement negotiations, often through a law office. Much of this depends on how obstinate the servicer on the first is.
Again, the thoughfulness in the comments shows greater depth, thinking and analysis than the early articles and early blogs about the new law. I wonder if any of this came up in committee hearings? I haven’t dug deeply into the committee reports and it takes a lot of work to get the actual hearing records. When one sees how superficial the new law is, one can see why the banks didn’t oppose it.
I have a question —
We are in escrow on a short sale. The sellers have a 1st (Chase) and a 2nd with PNC Bank. Everything was approved (we were in escrow) and then got our appraisal back. It came in $100k less than what we offered. We countered back to Chase and just got an approval today with the amount we offered — all conditions remaining the same. The amount they were paying to the 2nd stayed the same. The sellers contribution was about $10k over the amount the 1st was giving them. The sellers have put a call into PNC to make sure that they can’t have PNC go after them for the deficiency since the original letter is before SB458 and it states PNC can go after them for the deficiency. I called PNC on my own (actually spoke with a negotiator — not one assigned to the loan) and he told me the original 2nd approval letter was null/void. He said because it was based on PNC being able to collect on the deficiency. The amount that was initially approved was for lien release. Now, that they can’t go after the sellers for the deficiency, they will need a new approval letter and he said it’s generally in the neighborhood of 40-50% they collect. So, that brings the amount to a significant amount more than I know the sellers have or are willing to pay. They will foreclose and then file for bankruptcy. Our lender thought they couldn’t ask for more money now because no terms in their approval letter have changed and it was all signed. They are still getting the same amount according to the original letter. The expiration date of the letter isn’t until August 14th.
Again, I never spoke with the negotiator assigned to the loan and they didn’t give me specifics of the sellers loan but just what the general rule of thumb was. HELP! Any advice would be appreciated.
Hi JackM,
I’m going to send you a private message to discuss some specific ways you can deal with this that are more personal and private.
As for the more general pubilc issues, your situation evidences exactly what I expected: it will often be more difficult for sellers to receive approval from junior lienholders when the lienholder doesn’t have the potential for deficiency liability or seller contribution.
Moreover, it’s astounding that your appraisal came in $100k less than your offer! If this is a sound appraisal, then the real estate agents involved guided you down a ridiculously rosie path.
The banks “train” real estate agents to get the highest possible offer for a short sale and then the banks usually try to get an even higher price in the short sale “negotiations.” Hence, it’s important to come in with much lower offers than the real estate agents typically want because they have been so confused by the banks/loan servicers.
The new law voids the ability to collect a deficiency. It does not create any duty to tell the bank/servicer that the acceptance of the letter is not enforceable. Hence, I think it will usually be better NOT to tell the servicers of existing approvals that the law has changed. The law is effective and cannot be waived.
For existing approvals, I believe the lienholders have a legal ability to cancel the approvals because the law has changed. That’s a new fact which was not in play when the approval was made. With the great differences betweeen valuation and demands in this situation, I expect that the short sale will be a casualty of the new law — a clear case of unintended consequences.
A bankruptcy filing can often get banks to negotiate more reasonably but there is no guarantee that this will happen.
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