California Senate Bill (“SB”) 458 Prohibits Junior Lien Holders Collecting Post-Short Sale Deficiencies
As California credit unions are likely aware, the California legislature enacted SB 931 in 2010 to prohibit a lender receiving a judgment for any deficiency on a first (lien) mortgage or deed of trust following a short sale. SB 931 was enacted in response to legislative concerns that borrowers were being pursued by lenders for any deficiency remaining on the borrower’s loan after the lender received the short sale’s proceeds. Since SB 931 stated that it only applied to first mortgages and deeds of trust, many junior lien holders required borrowers to contribute additional amounts in addition to amounts paid to the junior lien holder out of the short sale’s proceeds.
In most cases involving a short sale for a home that is significantly “underwater,” a very limited amount of the short sale’s proceeds are paid to a junior lien holder, leaving the junior lien holder with a large remaining deficiency amount on its note. For example, in the event that the first mortgage or deed of trust holder is subject to the Fannie Mae Home Affordable Foreclosure Alternatives (“HAFA”) Program, Fannie Mae prohibits payments from short sale proceeds to junior lien holders that exceed $6,000, which often leaves junior lien holders that approve a short sale with significant, six-figure deficiency amounts remaining after the short sale occurs. Consequently, many junior lien holders required further contributions from borrowers as a condition of approving a proposed short sale, such as by requiring borrowers to make cash contributions or execute a separate unsecured note; in many cases, realtors agreed to make separate payments to a junior lien holder out of the realtor’s commission to facilitate the junior lien holder’s approval of the short sale.
As a result, to protect borrowers from having to pay deficiency amounts after a short sale is approved, the legislature enacted SB 458, which took effect on July 15, 2011; the bill was co-sponsored by the California Association of Realtors. SB 458 expands the protections available to borrowers by applying to all mortgages or deeds of trust, regardless of lien position, on a dwelling of four units or less. Further, SB 458 generally prohibits any collections on remaining balances after a short sale and bars lenders from requiring a borrower to pay any additional compensation in exchange for the lender’s consent to the proposed short sale. SB 458 provides limited exceptions, such as if a lender seeks damages against a borrower for fraud or waste.
As a result, prior to approving a proposed short sale on a property subject to its junior lien, your credit union will need to keep in mind that SB 458 prohibits it from asking for or requiring any compensation beyond the amounts to be paid out of the short sale proceeds. Your credit union may also be less likely to approve a proposed short sale as a result of the changes under SB 458, depending on the value of the property, the borrower’s financial condition, and other factors it will need to consider as part of its due diligence review of any proposed short sale. Our office can provide assistance if your credit union has any questions regarding SB 458 or any other issues related to short sales.