On June 3 of this year, Senate Bill 1178 (Corbett) was passed by the California State Senate and sent on to the Assembly. A California Association of Realtors® news release described this as a "victory for consumers." Inasmuch as not all consumers, nor their real estate agents, may realize the exact nature of this victory, it seems worthwhile to devote some attention to it.

When it comes to foreclosures, some states allow for deficiency judgments. That is, if the property sold at foreclosure does not generate enough money to pay off the loan balance, the lender may then pursue the borrower for the remaining difference. While California does allow for deficiency judgments in some foreclosure situations, there are also circumstances – quite common ones – where it does not. It does not allow for deficiency judgments in the cases of foreclosure when the loan(s) being foreclosed upon were "purchase money" loans for a personal residence. If you are being foreclosed on the loan you obtained to buy your home, the lender cannot also obtain a deficiency judgment, even if the price at auction does not cover the loan balance.

Consider some examples:

1. When you bought your home, you obtained both a first and a second trust deed in order to make the purchase. Neither one can obtain a deficiency judgment upon foreclosure.

2. When you bought your home, you obtained a first trust deed in order to make the purchase. Sometime later you took out a second trust deed in order to do some remodeling, go on a vacation, help with college expenses, etc. A foreclosure on the first could not also obtain a deficiency judgment; but a foreclosure on the second could.

3. When you bought your home, you obtained a first trust deed in order to make the purchase. Sometime later you refinanced that loan for the same amount (no cash out) and replaced it with a new loan at a lower interest rate. If that newer loan were foreclosed upon, it would be possible for the lender to pursue a deficiency judgment, because it is not a "purchase money" loan.

SB 1178 targets a perceived unfairness in the third example. Its proponents argue that it is not fair to remove the anti-deficiency protection afforded the original loan if the amount of the indebtedness has not been increased. The provisions of SB 1178 extend anti-deficiency protection to subsequent loans that merely replace original purchase money loans.

When SB 1178 was first introduced in February, it reached a bit further. It would have extended anti-deficiency protection also to subsequent loans that were used to construct or improve the property. That brought about amendments that would have put a burden of proof on the borrower. Finally, it was simplified to apply only to the amount of a subsequent loan that equals the amount originally borrowed in order to purchase the property. Suppose, for example, your original purchase money loan was $200,000 and that you subsequently replaced that loan with a loan for $250,000. You might have used the extra $50,000 to improve the property, or not. It doesn’t matter. In the event of foreclosure, the first $200,000 would be protected from a deficiency judgment, but not the extra $50,000.

SB 1178 is now in the California State Assembly. If it passes into law in its present form, it will become effective June 1, 2011, and will apply to actions after that date. The bill faces opposition from a variety of lending organizations including the California Bankers Association, California Mortgage Bankers Association, and the California Credit Union League. The bill is sponsored by the California Association of Realtors®.