Law Offices of Graden R. Tapley

Over the last few years many private investors put their money in second mortgages (promissory notes secured by deeds of trust on real estate) thinking they were a secure way to earn reasonable interest. Many of these investors have been left without any security for repayment after borrowers defaulted on their first mortgages and the properties were sold at foreclosure auctions.

The foreclosing first mortgage lender is usually an institution like a bank. Banks usually hold a simple trustee sale of the property. If the sale does not fully repay the loan the bank just writes off the loss.

It is harder for the second mortgage lender to just write off loss. First, the second lender usually loses everything, not just the difference between the sale price and the loan. Second, many second lenders are individuals and families who have invested their retirement savings. In this case the loss is devastating.

Some of the borrowers that defaulted on their first mortgages were buyers of second and third investment properties. These borrowers still own other property, sometimes with considerable equity. Finding out is not expensive. Public records are indexed by name in each county. There are companies that will handle the search for $50 or less.

If a borrower owns other property a sold-out junior lender can, in some cases, use it to repay the debt. This requires a court action for failure to repay the note. Most notes allow the lender to add their attorney fees to the debt as well as court costs.

If you are a sold-out junior lender holding a promissory note it might be worth considering whether your borrower has the ability to repay through other equity than the property borrowed against.

From Sebastopol, the Law Offices of Graden Tapley represents clients throughout Sonoma County, including Santa Rosa, Cotati, Healdsburg, Petaluma, Rohnert Park, Santa Rosa, and Windsor.

What If The Foreclosure Sale Does Not Pay Off My Mortgage?

Question : I am in default on my mortgage and have received a “Notice of Default and Intent to Foreclose” from the lender. What if the lender sells the house and the sale price does not pay off the loan?

Answer : A borrower’s biggest worry is that a foreclosure sale will not cover the amount of the loan and the lender will sue for the difference or come after a borrower’s other properties, especially the property that the borrower lives in.
A lender generally has two foreclosure options when a borrower defaults on a mortgage. First, the lender can hold a “trustee sale” using the power of sale clause in the deed of trust. Second, the lender can file a lawsuit asking the court for an Order that the property be sold at an auction, (a “judicial foreclosure” sale). A trustee sale is fairly quick and inexpensive. On the other hand, a judicial foreclosure sale takes a long time and is more expensive. The lender can choose only one of these options, not both.

Deficiency Judgments
Why would a lender ever choose the court route over a trustee sale? There could be many reasons but the typical reason is that the lender not only wants to sell the property but wants to come after the borrower for the remainder if the sale does not pay off the loan. This is called a deficiency judgment. (A deficiency judgment is a money judgment which can be recorded against any real estate as a judgment lien. It is possible to foreclose on a judgment lien, subject to federal and state debtor’s protections).

No Deficiency Judgment After A Trustee Sale
A lender is prohibited by law from suing a borrower in court and getting a deficiency judgment after the lender has sold the property at a trustee sale. In other words, once there has been a trustee sale the lender may take no further action against the debtor. If a lender knows that a borrower has a large bank account or another property with plenty of equity and the trustee sale is likely to come up short that lender might choose to spend the extra time and money for a judicial foreclosure and get a deficiency judgment also. That is- if the lender has the choice.

No Deficiency Judgment For A Purchase Money Loan
Lenders do not always have a choice. If the loan was a “purchase money loan,” (which means the loan was obtained so the borrower could pay the seller when buying the property), the lender is not entitled to a deficiency judgment.

The purchase money debtor’s protection law was enacted in 1933, the worst year of the Great Depression after the stock market crash of 1929. After the crash property values declined rapidly and many properties were worth less than the loans they secured. (Not much different than today.   At the time of this article (Spring/2008) it is estimated that as much as 10% of all properties in the United States are presently worth less than the loans borrowed against them.)

In 1933 the California Legislature declared that “ in no event ” shall a deficiency judgment lie after a debtor defaults on a purchase money loan secured by a deed of trust. One purpose of the prohibition was “to discourage land sales that are unsound due to overvaluation of the land, and in the event of a depression in land values, to prevent the aggravation of the downturn that would result if defaulting purchasers lost the land and were burdened with personal liability as well.”

By forcing additional risk on lenders they became partial protectors of the economy by preventing land sales with over-inflated prices. Lenders became blind to their role in the marketplace in the 1990s because it seemed like real estate prices would never stop appreciating- even though the Federal Reserve Bank warned that prices were exceeding value in real terms. If lenders had been more cautious about lending we might not be in such a financial crisis right now.

Exceptions to “In No Event”
The “in no event” language in the protection is still on the books today. But don’t be fooled- there are exceptions. Courts have held that the lender is only prevented from obtaining a deficiency judgment for loans made in a “standard purchase money situation.” If there were any variations from the standard situation the prohibition does not apply.

For example, if the loan was a later refinance, a subordination agreement (typical in construction loans), a later second mortgage, or a personal guarantee, the rule does not apply and the lender is entitled to a deficiency judgment.  Also not protected are dwellings not occupied by the borrower, dwellings for more than four families, and bare land.  See an attorney for a complete list and analysis of the exceptions.

Courts examine each case to determine whether it falls within the protection and whether it qualifies for a exception. It the facts show that it was not a standard purchase money situation or does not fit within the purposes of the rule (e.g. discouraging unsound real estate purchases and preventing aggravation in a recession by saddling borrowers with personal liability) then a deficiency judgment will be allowed.

This article is based on general law and facts.  It is not intended to apply to the particular circumstances of any one person.  To understand how the law applies to your specific situation you will need to consult with an attorney.

From Sebastopol, the Law Offices of Graden Tapley represents clients throughout Sonoma County, including Santa Rosa, Cotati, Healdsburg, Petaluma, Rohnert Park, Santa Rosa, and Windsor.

Right now we are experiencing a melt-down in County real estate values. This is being fueled mainly by the epidemic of foreclosures that are occurring daily. The foreclosures are pushing prices to lows that nobody expected. Hundred of Sonoma County residents purchased property with sub-prime loans and are now subject to foreclosure. As much as 20% of all recent sales in Sonoma County were a result of foreclosures. As much as 10% of all property today is worth less than the money borrowed against it.

“Predatory Loans”
Many of loans being foreclosed on are being called “predatory” because they were made to people that could not afford them. Mortgage brokers have a duty not to loan money to borrowers that have no apparent present ability to pay for the loan. It is a breach of a duty to the borrower to make a loan to a person that has not established an ability to pay. However, on the other hand the broker is entitled to rely on financial statements of the borrower as to stream of income.

In some cases predatory loans can be rescinded. For example, if the lender charged brokerage fees and costs that exceed the legal limit the borrower will have limited rights to rescind the loan. Each case depends on its specific facts and requires a study of the finance documents. If the loan cannot be canceled or rescinded then the borrower must consider other options. In some cases borrowers may be worried whether the bank can collect the debt from properties other than the one mortgaged. These answers require individual consultations.

Help After A Predatory Loan
Real estate finance issues arise both out of state laws such as the Finance Code and the Business and Professions Code as well as federal laws such as the Truth In Lending Act (TILA), Regulation Z, and Real Estate Settlement Procedures Act, (RESPA) to name a few. However, some of the real estate law that attorneys deal with on a daily basis are rules that come from court decisions. The language in the real estate laws are further defined as disputes arise and are handled in the courts. Each dispute raises specific issues that have to be interpreted with respect to how the laws are to be applied. These laws evolve over time because one judge may overrule a former decision.

From Sebastopol, the Law Offices of Graden Tapley represents clients throughout Sonoma County, including Santa Rosa, Cotati, Healdsburg, Petaluma, Rohnert Park, Santa Rosa, and Windsor.