Recently the California legislature took action that will expand anti-deficiency protections for California mortgage borrowers. Another way to put this is to say that the legislation enlarges the class of non-recourse loans in California.
A recourse loan is one in which the lender has the right to go after other financial assets of the borrower in the event that (a) the borrower doesn’t repay the loan and (b) the asset(s) given to secure the loan - i.e. the collateral - is not of sufficient value to fully repay the loan.
Suppose, for example, that a borrower takes out a $400,000 mortgage loan in order to purchase a $500,000 home. Suppose further that, after the crash, the house in now worth only $350,000. The borrower defaults and the lender forecloses. If the lender only gets $350,000 and the loan is recourse debt, then the lender could pursue other assets of the borrower in an attempt to recover the $50,000 difference.
If the loan were not a recourse loan, the lender could not take action to recover the deficiency - the difference between what was owed and what was received.
In many states, mortgage loans are recourse loans. Foreclosure may not be the end of the borrower’s problems. Collection actions may follow.
In California, as in some other states,some mortgage loans are non-recourse in nature. These are said to have anti-deficiency protection. California law provides that a loan used to acquire a residential property (1 - 4 units) which will be occupied by the owner is a non-recourse loan. If the property goes to foreclosure, and if there is a deficiency, that is the lender’s tough luck. No further action against the borrower is available.
But what if the original non-recourse purchase money loan has been refinanced? Suppose that the $400,000 loan (above) had subsequently been refinanced at the same principal amount but at a lower interest rate. Would the new loan also be non-recourse? Not under current California law. If a judicial foreclosure of the new loan did not yield funds sufficient to pay it off, a deficiency judgment would be available to the lender.
The new law will change that. California Senate Bill 1069 (Corbett) provides that there shall be no deficiency judgment available on any loan "which is used to refinance a purchase money loan, or subsequent refinances of a purchase money loan…"
With one exception. Suppose, as is often the case, the refinancing was for a larger amount than that owing on the original loan. Suppose it is a "cash out" refi. The original loan was $400,000, but values increased enough for the refinance to be at $500,000. Now, if that loan were foreclosed on, the anti-deficiency protection would only extend to the amount needed to pay off the original purchase money loan. The rest ($100,000 in the example) would be recourse, subject to further collection action.
Senate Bill 1069 was passed by the legislature and in July it was approved by the Governor. It amends section 580(b) of the Code of Civil Procedure. It becomes effective January 1, 2013, and it will apply only to loans executed after that date.