Most people now know that lenders can’t come after borrowers for losses on purchase money loans. Unfortunately many folks lost that protection when they refinanced as the law, Civil Code of Procedure 580b, only applied to the original loan. Senate bill 1178 intends to fix that by extending 580b, the “purchase money rule” to any refinance of that original amount. Note that the protection would still NOT extend to owners that did cash-out refinances, and that makes sense. The whole idea behind the purchase money rule is that the borrower would not have been able to buy the home without the lender, that lenders are more sophisticated than borrowers, and therefore lenders should bear the risk if they make too large a loan for a given property… basically eliminating the lenders ability to come after the borrower personally should the borrower default, and there not be enough value left in the property to cover the loan.
With the likely enactment of SB 1178 right around the corner, it seems a good time to revisit the issue of whether the lender on a purchase money 2nd deed of trust can go after a borrower when the lender on the 1st deed of trust forecloses “wipes out” the 2nd deed of trust. The answer is “No” and an enactment of SB 1178 amending CCP section 580b does not change that. On the contrary, SB 1178 will broaden the borrowers protection.
To begin, the California Supreme Court decided in Brown v. Jensen (1953) 41 Cal 2d 193 that CCP section 580b applies to a junior purchase money mortgage when the security has been rendered valueless by the foreclosure of a senior mortgage. In Brown v. Jensen the defendants bought their home from the plaintiff with purchase money borrowed from Glendale Federal Savings & Loan secured by a 1st Deed of Trust and plaintiff carried back a portion of the purchase price secured by a 2nd Deed of Trust. Glendale foreclosed and the property went back to Glendale at trustee sale for the opening bid. The trustee’s deed was recorded in favor of Glendale and the 2nd Deed of Trust held by plaintiff was wiped out.
Plaintiff unsuccessfully argued that security on the debt (the second trust deed) had become valueless because it had become exhausted by the sale under the first trust deed so she was not limited by the “one action rule” of California Code of Civil Procedure section 726. In denying the plaintiff relief the Court asked the question; did plaintiff take a purchase money trust deed on the property when it was purchased? If she did, then Civil Code section 580b was applicable and she could look only to the security because by taking such a trust deed she knew the value of his security and assumed the risk that it may become inadequate. The Court pointed out that the rationale was especially true when the lender knowingly takes on a 2nd deed of trust, which has a greater risk that the security could become insufficient.
SB 1178 serves to broaden 580b with the following “new and improved” additional language:
“For purposes of this section, a loan used to pay all or part of the purchase price of real property or an estate for years shall include subsequent loans, mortgages, or deeds of trust that refinance or modify the original loan, but only to the extent that the subsequent loan was used to pay debt incurred to purchase the real property. (Emphasis added.)”
So SB 1178 applies to the refinance of “a loan” used to purchase the property, regardless of whether the loan has senior or junior status, most commonly a 1st deed of trust and a 2nd deed of trust. Assuming the law is enacted in similar form as is now being considered in Sacramento, folks can feel comfortable that they are not exposing themselves to personal liability by refinancing any or all of their purchase money loans, regardless of the loan’s seniority.
I have a purchase money 2nd of 84,000 tied to my house that i currently live in that I purchased with equity from my original house. Long story short I have to foreclose my current living house but am afraid of the purchase money 2nd . I spoke with a lawyer and he said they will go after me. True or Not? And how will it affect me trying to modify my original house that I plan on moving back into. I need your knowledge! Thank you
Hi Annie,
Based on your comment, I think that you may want to get another lawyer’s opinion. We, of course, are not in a position to give you legal advice, but our read of 580b is that a lender on a purchase money 2nd deed of trust cannot go after a borrower when the lender on the 1st deed of trust forecloses “wipes out” the 2nd deed of trust. As for your other question, I suspect that the lender on your original home will consider your foreclosure status on your current residence when working on a loan modification, but know of no reason why that that status will be determinative.
I am not an Attorney:
If the purchase money 2nd was a”cash out loan” e.g.
you refinanced for more than your original mortgage and retained the extra cash, then you could be liable. However, in the state of California, we have none judicial foreclosures, and the Bank would have to obtain a Judicial Foreclosure.
That is my understanding of the situation
Currently 580(b) protection only applies to purchase money loans that are foreclosed. Will the new bill also apply to properties that are short sold or just to refis?
Hi Michael,
SB 1178 will not change the application of CCP 580(b) to properties sold at trustee sale. There is no trustee sale when a property is sold short, before the foreclosure. As importantly, the borrower will need to reslove the obligations with all lienholders before a short sale can close, so it would seem that there really is no need for 580(b) application in any event.
Thanks, Mark. While it will be helpful to have 580(b) protection extended to refis, it would be more more helpful to have the word “sale” in 580(b) defined to include a short sale or other lender disposition in lieu of foreclosure so that purchase money loans would be truly non-recourse, and not just non-recourse after a foreclosure.
It’s a bit sneaky for a lender to approve a short sale on a purchase money loan, and then take the position that a deficiency is owed because the disposition was not a foreclosure.
I would argue that there should be consideration given to including short sales if you agree with the premise that short sales are an important way to get through the mess we’re in. From personal experience and in dealing with many sellers in our real estate business the reality is that even when using qualified negotiators the scenario that seems to play out is that you when get down to closing is that the First is on board the second agrees to say, $5000 on a $50,000 loan. But before they will allow the closing you have to sign that you are still personally responsible. So the question becomes which is better foreclosure or short sale?
I had couple of small problems viewing the site in Firefox on Linux, but apart from that loved the post.
Hi Marcelo,
Glad you liked the post. If you have browser problems again, feel free to email support at ForeclosureRadar.com. There are technicians standing by to help you.
Susan’s absoluetly right, a lot of junior lienholders are having the Seller’s sign their approval letter which states that they can still come after the Seller in the future for the unpaid balance. Interesting news none the less, I still get questions all the time regarding purchase money 2nds and whether or not they are wiped out thru the foreclosure of the 1st.
I am in default with my mortgage. I read about SB 1178. Is it only going to protect the cases that will be filed after Jun 2011?
NO, I believe it is retroactive to 2003.
Can you tell me where this belief came from? I hope it is true but I cannot find anything to support it. I am however finding things that state it will only apply to actions filed after June 1, 2011.
I’m glad I came across this information because I’m planning on moving to Palm Springs and I’m not a California resident now. SB 1178 looks like a good bill. I found a great real estate agent at Patrick Stewart Properties and I’m sure he’ll fill me in on all the details when I go out there to start house hunting, and dealing with the financial side of buying a house. At least I will have an understanding of SB 1178 when I get out to California since I read your post.
I am currently being pursued by a collection agency on a purchase money second that closed in 2009. The home in CA was short sold and the lender owned botht he 1st and 2nd. I received closing papers that said they would accept $3,000 on the second showing charged off but the bank may go after the balance. I was not given a choice to not signe. They would not have accepted the 1st and 2nd short sale. Do I have any recourse with sb1178 being passed? I used the money on the second to put a backyard in. I did not use the money to buy a car or go to Tahiti. I have moved out of state and both husband and I have taken jobs less than half of what our income was in CA. We had to move due to elder mother needing help.
Cozette: The SB 1178 is only effective for actions after June1, 2011, so it would not apply to your case. Your situation is unfortunate. If you had allowed the home to be foreclosed, there would have been no deficiency under either the first or the second because they were purchase money. However, short sales do not come under the protection of 580b.
Mucho thanks for useful information. Keep up the neat work. I’ll be returning often.
HI, I WANTED TO KNOW IF THE SB 1178 HAS BEEN OFFICIALLY APPROVED/PASSED ? MY DAUGHTER HAD A FORECLOSURE IN 2009 BY THE 1ST TD HOLDER AND THE 2ND TD (PURCHASE MONEY LOAN) HAD BEEN REFINANCED WITHOUT ANY CASHOUT BEFORE THE FORECLOSURE. SHE IS BEING PURSUED BY CREDITORS FOR THAT LOAN AND HER CREDIT CONTINUES TO BE TAINTED. DOES SHE HAVE ANY RECOURSE?
@Herrera: Sorry, but the governer vetoed this bill at the end of September. I have not heard if the Senate will attempt to overturn the veto. With new legislatures, it is anyone’s guess.
We’re in foreclosure with NOD filed and Notice of Sale filed. 1st is a refi w/cash out but documented use of funds for remodel. Same is true for the 2nd. Working with realtor on short sale, received and signed a decent Offer and submitted to bank. Bank is working on short sale but is asking for full financial disclosure which will show 200K in non IRA retirement savings. If we disclose and short sale falls through, can the bank elect to switch from non-judicial to judicial foreclosure, using the financial info gathered to pursue deficiency in judicial foreclosure???
I have a 1st and 2nd. The first was refinanced to pay off debt and the remaining used in conjuction with the 2nd to open a business that ended up closing due to the economy. I have a pending short sale on my home, but don’t really understand what the reprecussions of a short sale may have on me in my situation vs. a foreclosure. Both attorneys that I’ve spoken with tell me that the if the bank forecloses I am still liable to pay the 2nd, so I would have to file bankruptcy before the foreclosure were to happen if I wanted to avoid the 2nd coming after me. Because I do have a pending sale, the forclosure is on hold, but there is no guarantee that they won’t foreclose anyway if the sale doesn’t go through before the sale date. Do you know if/how SB 1178 can protect me?
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My ex husband and I foreclosed on our home back in June 2010 after first placing it on short sale for a year. We bought the house in September 2004. The second mortgage did not accept any of the short sale offers. My ex husband recently received a letter from that second mortgage company stating we still owe approx $140K for that second mortgage. We thought that once foreclosed both mortgages are forgiven. The letter also stated that since we took out $30K of home equity in November 2008, we are liable for the entire mortgage. They did mention the Debt Relief Act in which best case scenario, the amount owed can be $15k. We do not have the means to pay back this company. Can you please provide me with more information? Thank you.