California Short Sales Directly Affected by 2011 Law Modification

New Change in Law

Modifying an existing consumer protection law associated with mortgages on residential properties of 1-4 units, Senate Bill 931 was codified and became California Law as Civil Code of Procedure (CCP) 580e effective January 1st.

This change extended protection against pursuit of deficiency by lenders who approved short sales to EVERY first deed of trust – regardless of whether the property was a primary residence or the deed of trust was recourse or non-recourse.

On Friday July 15th 2011 Governor Brown signed Senate Bill 458 into law. It (again) modified this law and included terms that made it effective immediately upon signing.

The change is significant. CCP 580e now extends protection from pursuit of deficiency to ANY deed of trust that approves a short sale and agrees to accept less than the amount owed. With these new changes junior lien holders (more commonly known as 2nd loans) can no longer pursue a deficiency judgment after the short sale has been approved and the sale closed. In summary, with the new amendment to this law, NO lender who approves a short sale can require that the borrower pay back the amount of debt forgiven. If and when a short sale is approved and the lender has agreed to accept the agreed upon amount, they must release the existing lien and waive any future deficiency claims.

Initially, organizations like the California Association of Realtors are supportive of the new change. This is likely due to the extension of protection to consumers but may not consider how lender/servicer/investor reactions will impact the already beleaguered housing market.

It is possible that lenders/servicers/investors in junior positions will begin to require higher settlement figures before approving a short sales. This increase can only come from a fixed group of sources that are part of the total settlement cost of the transaction: the first lien holders, the seller/borrowers or the buyers.

In most situations the seller/borrower is not positioned to contribute funds to a junior lien holder in order to secure an approval. Further, since the primary or first lien holder must be paid first there is little or no incentive to accept a short payoff with any available borrower/seller funds going to a junior lien holder – the holder of the first will want all available funds to GO toward payment of the first.

Additionally, the buyer, who is already purchasing the property at fair market value, has no incentive to contribute funds above the purchase price.

Presently, neither lenders/servicers/investors, buyers, sellers nor the real estate community know exactly the ramifications of this newly implemented law or how short sales will be managed by junior lien holders in California.

This new legislation has redirected the way we are now advising our clients regarding short sales and strategic defaults. This new law affects California deeds of trust only and does not apply to properties held in other states. Be aware that changes are being made regularly at both Federal and State levels so it is increasingly important to work closely with well informed professionals who can provide up to date information and who have access to strong networks both in and outside of California.