SEVERAL clients walked in the door recently wondering if they were legally liable on second trust deeds on their residences that were foreclosed last year. Some of them managed to ‘short sell’ the house with the consent of the 2nd trust deed holder who is coming after them with lawsuits. When a house is foreclosed, there may or may not be a ‘foreclosure deficiency’.
A deficiency arises when a creditor secured by the house is not paid in full by the sale proceeds received in the foreclosure. When the property has a large equity when foreclosed, the probability of a deficiency is small. When the house has no equity, it is certain that there will be a deficiency. The homeowner is legally liable for the deficiency should there be one. It seems to be unfair that debtor still owes something when the house is already lost. But that is the way it works in most cases in California. To illustrate, client’s former residence had a fair market value of $200,000 at the time of foreclosure. There were 3 trust deeds or mortgages on the property. The first trust deed was held by IndyMac with a balance of $400,000. The second trust deed was a Heloc line with a balance of $100,000. The third trust deed was a business loan for $50,000. Does client legally owe anything after residence is foreclosed? The answer is yes. Client does not owe anything on the first trust deed even if the entire balance of $400,000 was not paid when foreclosed because there is no deficiency collectible by a first trust deed holder if the foreclosure is extrajudicial. Most foreclosures in California are extrajudicial. If the foreclosure is done judicially, creditor can obtain a judgment for the deficiency but not if the foreclosure happened between 2007 and 2009 because the deficiency law was suspended in that period of time. Client still owes the Heloc line of $100,000 because no portion of the debt was paid in foreclosure. And client still owes the business loan of $50,000 for the same reason. Thus, after foreclosure, after debtor loses his residence, he will still owe $150,000 of ‘foreclosure deficiency’. Why does it work like this? Answer: debtor signs 2 documents when he offers his house as collateral for a loan. One document is the trust deed or the collateral agreement giving the house as security for the loan. The other document is called a promissory note where debtor promises in writing to pay back the loan. When the house is foreclosed, the trust deed is extinguished because the collateral is gone. But the promissory note remains and in the promissory note debtor promises to repay the loan even if the collateral is gone. The promissory note signed by debtor is the legal basis to collect the ‘foreclosure deficiency’.
The same principle applies in a ‘short sale’ where the sale proceeds are not enough to pay the outstanding balance of a junior trust deed. In this example, if the house was sold to a third party with the consent of the first trust deed holder for $200,000, it normally means that the first trust deed holder agreed to receive $200,000 in full satisfaction of the $400,000 balance. Creditor will issue a 1099 for the difference of $200,000 to debtor because creditor forgave $200,000 in this short sale and forgiveness of debt is considered income by the IRS. What happens the 2 other trust deeds in a ‘short sale’? Their consent to the short sale must be obtained in writing in order for the escrow to close and for the new grant deed to buyer to be issued. These creditors may agree to the ‘short sale’ just to allow the escrow to close, but they normally will not agree to release debtor from liability on the notes. Thus, escrow will close but debtor will still owe creditors for the full amounts on the second and third trust deeds.
If you need debt relief, contact my office. I will analyze your case personally.
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Lawrence Bautista Yang specializes in bankruptcy, business, real estate and civil litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S. Fremont Ave., Bldg. A-1 Suite 1125 Unit 58, Alhambra, CA 91803. (Advertising Supplement)
( Published April 24, 2010 in Asian Journal Los Angeles p. C5 )
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