One of the home refinance pitfalls for Californians bit the dust.
Starting January, 2013, antideficiency laws that protect home loan borrowers from personal liability have been expanded to include a refinanced purchase money loan.
If a borrower refinances a loan used to buy a property in which he will live, he will no longer lose the legal protections given to purchase money loans.
If the refinanced loan pulls money out, the borrower will have personal liability only for the amount of the new loan that exceeds the amount necessary to retire the original loan, plus the transaction costs of the new loan.
Great, you say, but what does this really mean?
For first position home mortgages, the change isn’t terribly dramatic.
If the bank forecloses on the senior lien on your home, you don’t have to worry about personal liability. California’s one-action rule says that a creditor who forecloses gives up the right to sue the debtor for a deficiency.
That’s the rule whether the loan is purchase money or not, or whether the property is your home or an investment.
The expansion of non recourse status is a much bigger deal when applied to liens in second position on a property.
Suppose you bought your home with a senior loan for 80% of the property’s price, and a second loan for the balance of the purchase price.
Because that junior lien secures a purchase money mortgage, the antideficiency provisons of the law protect you from ever being sued for the loan balance.
Until this change, you lost that purchase money protection if you refinanced the loan for a better rate or better terms.
If the senior loan foreclosed, and you had refinanced the purchase money second, you could be sued for the debt, your wages garnished and your bank accounts levied.
For loans made after January 1, 2013, the result changes.
The refinanced junior lien retains the non recourse protections. If there’s a foreclosure on the senior lien, your personal liability on the second position lien is only the amount of any cash out of the refinance.
Other benefits of change
The expansion of non recourse status will affect the tax consequences of foreclosure tied to the cancellation of debt.
If you have no personal liability for a loan, then a foreclosure or other forgiveness of that debt doesn’t alter your balance sheet. You didn’t owe the loan before the foreclosure; the cancellation of the debt via foreclosure doesn’t change your net worth.
Again, if you qualify for the federal safeharbor on cancellation of debt, and that law remains in effect, nothing changes. But state law doesn’t exactly parallel the federal law on home loan debt forgiveness. Either state or federal law may change.
Here’s the text of the newly amended California Code of Civil Procedure 580(b).
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