Foreclosure is traumatic enought without worrying whether lenders can sue you after foreclosure.
Breathe deeply. California has laws that limit what a mortgage lender can do to collect its money after the foreclosure. One addresses the rights of the creditor who conducted the foreclosure sale. The other borrower protection looks at what the loan was used for in assessing the creditor’s rights.
Foreclosure sale is sole remedy
California is a non-judicial foreclosure state. That means that a lender holding a deed of trust on real property doesn’t need to file a lawsuit to foreclose. The power of sale in the deed of trust the borrower signed gives them rights to hold a foreclosure sale without judicial supervision.
When a creditor with a consensual lien on real property uses the power of sale to hold a foreclosure sale, the creditor gives us any other collection rights on that loan.
The foreclosure sale is an election of remedies. The creditor elected to use the relatively streamlined non-judicial sale and waived its rights to collect any shortfall after the sale. This is sometimes called the “one-action” rule.
Loans to purchase homes have limits
There’s a second protection for homeowners who have been foreclosed upon.
California has a special limit on the rights of a secured creditor when the loan secured was used to purchase a principal residence. California Code of Civil Procedure 580b provides that a lender may not sue a borrower after a sale when the loan was used to acquire a home.
This Depression-era statute puts the risk of non payment solely on the lender who made the loan to buy the property. The lender’s sole remedy is to foreclose on its deed of trust.
The most frequent application of this statute is when there are two loans on a property and the senior-most lienholder forecloses. The foreclosure sale wipes out the lien that was junior to the foreclosing creditor. (The debt to the junior creditor survives, but not the lien on the property.)
The rights of the junior creditor to sue on the surviving debt depends on the use of the loan proceeds back when the loan was taken out. If the loan enabled the purchase of the home, the cut-off junior lender can’t sue to collect the debt.
If the loan was taken out by a borrower for other purposes, such as remodeling, business, or payment of other bills, the lender can sue to collect the outstanding balance. Such a loan doesn’t fall within the anti deficiency provision because it wasn’t used to acquire the home.
I was reminded of the purchase money antideficiency statute yesterday when meeting with a client who took out two loans to buy a home. The home was now in foreclosure.
For that client, the fact that both loans on the troubled property were taken out to buy the house protects them from any future collection action by either lender.
This client didn’t need bankruptcy protection on account of the foreclosure. They’ll be survivors of the mortgage meltdown.