Short Sale Lien Deficiency Rights
Short Sale Lien Holders No Longer Have Any Deficiency Rights
California Senate Bill 458 was signed into law on July 15, 2011 and is effective immediately for all short sale transactions that close after July 15, 2011. The law provides that junior lien holders no longer have any deficiency rights against the borrower after a short sale. (A previously enacted law enacted in 2010 banned senior lien holders from collecting deficiencies after short sales). The new law prohibits deficiency judgments after short sales and further prohibits lenders from requiring payments of any deficiency amounts. Although lenders are prohibited from requiring payment of additional compensation in exchange for short sale approvals, borrowers can voluntarily offer a monetary contribution to the lender in hopes of obtaining short sale approval.
This law is being hailed as a major victory for borrowers because it removes the potential for deficiency liability after the short sale is completed and thus brings more certainty to the short sale process for borrowers. Additionally, it is hoped that by removing this negotiating impediment, that the short sale process will be quicker and smoother. What is very important to note is that this law affects all pending but not yet closed short sales. If the lenders are aware of the new law, some junior lien holders may try to renegotiate the terms of already approved short sales. This may throw a wrench into a short sale that was on its way to closing. However, at the same time some borrowers with pending short sales may receive a windfall because their lenders will not become aware of the new law before their transaction closes and they will escape deficiency liability from a lender who intended to go after them.
An exception to the new law is if the borrower commits any type of fraud related to the short sale. Generally this would involve the borrower lying in the short sale application about their income, assets or hardship status. A second exception will occur if the borrower commits waste on the property such as intentional damage or they are grossly negligent in their neglect of the property. In these circumstances the lenders would be allowed to seek appropriate damages from the borrower.
There is a significant possibility that the new law may not work as intended. Short sales will still require the approval of all lien holders on the property in order to close. Junior lien holders may be less likely to approve short sales now with the new law. This is because before the law was enacted, a junior lien holder would receive funds from the short sale of a property in which there really was no equity for them. This was in essence a bonus amount that the short sale provided to them and after the sale closed they could then proceed against the borrower for the deficiency.
Now because of the new law, larger junior lien holders may decide that it is more to their financial benefit to simply deny approval of the short sale if in their analysis they believe they will recover more money from pursuing the deficiency against the borrower instead of accepting the small amount they receive from the short sale. Thus, the law may have the unintended results of reducing the total number of short sales which would force more borrowers into foreclosure. Another slippery slope is the junior lien holder that was re-financed or was an equity line of credit. Those types of loans are always grey areas with regards to this law as well.
The terms of the law also permits lenders to request or negotiate for a contribution from parties other than the borrower, such as from other lenders, real estate agents or other parties.
This page is strictly for informational purposes only. If you need any legal, tax, or financial advice when it comes to this new law, you are advised to contact your attorney, tax or financial professional.