Unpublished Papers

What Your Lender and Mortgage Broker Didn’t Tell You:

George W. Kuney, University of Tennessee - Knoxville

Abstract

California Code of Civil Procedure § 580b protects a California homeowner from a deficiency judgment when the homeowner’s purchase-money lender forecloses upon the home after default. In other words, if the price the lender realized at the foreclosure sale is less than the outstanding amount of the debt, the homeowner will not be liable for the deficiency. Section 580b was enacted to discourage the purchase money lenders from over-valuing real property by requiring a lender to look solely to the collateral’s value for recovery in the event of foreclosure, and to prevent the aggravation of an economic downturn caused by increased debt exposure to homeowners during a depression. Section 580b’s protection cannot be contractually waived by the borrower.

The protection of § 580b only applies to purchase money mortgages. A lender may recover a deficiency judgment against a borrower who refinances an existing mortgage and later defaults, and a lender may recover a deficiency judgment with respect to any other non-purchase money loan, such as a home equity line of credit. If the protection provided by § 580b is not disclosed, borrowers often remain unaware of the anti-deficiency protection and that it is lost upon refinance. These borrowers risk losing protections which may prove substantial if the housing market slumps. Instead of having the right to walk away from the home, the refinancing borrower is liable for the full amount of the debt, including contract interest and fees and, if the debt is reduced to judgment, post-judgment interest at the rate of 10%.

The California Civil Code requires an initial disclosure of the anti-deficiency protection to purchase-money mortgage borrowers, but it does not require disclosure of the potential loss of that protection during refinancing. Moreover, lenders who are subject to the Federal Truth in Lending Act or the Homeowners Equity Protection Act required to make the disclosures required by the Civil Code because federal law preempts state law in this area. California is thus unable to enforce even its minimal state law requiring disclosure of anti-deficiency protection to purchase-money borrowers due to the pervasive scheme of federal lending and banking regulations. For the same reason, California cannot effectively expand this disclosure obligation to include disclosure of the loss of the protection upon refinance. The absence of an enforceable duty to disclose anti-deficiency protection or the conditions of its loss means that many borrowers—especially unsophisticated borrowers without legal representation (e.g., typical homeowners)—are vulnerable to losing the protection of § 580b without notice or recourse or even knowing that it existed in the first place.

This article urges that these disclosure omissions be cured. The recent slump in housing prices, along with the growth of sub-prime purchase money and refinance transactions with low or no equity requirements , underscores the importance to consumers of knowing their rights under § 580b and that they will loose them when entering into a refinancing transaction. Disclosure of § 580b protection in an initial purchase money financing transaction is important, but alone is not enough. Disclosure of its loss in a refinancing transaction is far more important to the borrower. Refinancing dramatically changes the risk allocation between lender and borrower of overvaluation of the collateral – the home – by shifting it overwhelmingly to the borrower. The true cost of refinancing, then, can only be known if the loss of § 580b anti-deficiency protections is factored into the equation. To be effective, this disclosure requirement should be required under federal as well as California law due to the preemptive and pervasive effect of the former on the latter.

Suggested Citation

George W. Kuney. 2007. "What Your Lender and Mortgage Broker Didn’t Tell You: " ExpressO
Available at: http://works.bepress.com/george_kuney/1

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