Guest-host Gary Laturno, a real estate attorney and broker, tackles your real estate questions today as part of Savvy & Sage: Tips on Buying and Selling in 2009.
Reader John J. Flynn asked what might be the bank’s reaction if a borrower defaults on a HLOC loan but keeps making payments on the first loan, the deed note. Flynn said to assume the property has negative equity, or that it would sell for less than is owed on the mortgages.
He also asked if California is “practically a deficiency judgment state.” And he wondered if lenders come after the borrowers if, when they resell the foreclosed homes, they don’t get enough money to satisfy the loan balance.
Thanks for your question. First, let me define a couple of things.
“Is CA practically a deficiency judgment state?” I am not 100% certain as to what you mean by this question. Let me comment. California has a consumer protection law that states that if one borrows money to purchase a home — called a “purchase money loan” — the lender must look to the home for repayment of the debt. There is no personal liability on a purchase money loan. If one does a refinance or takes money out after purchasing the home, however, that is called “recourse debt”, and the lender could look to the homeowner for repayment in the event of default.
A HLOC, for those who may not be familiar with the terminology, is an equity line of credit on the home. The funds are typically taken out of the home after one purchases the property. Hence the borrower is personally responsible for the loan in the event of default.
Now to get to the heart of your question: You have described a common situation in California: A home has two loans. The home has negative equity and the second (lender) knows it will be “wiped out” in the event of a foreclosure. What will a second lender do if the borrower defaults on the second loan? Answer: They will probably not file a notice of default and foreclose. If they did, they would take the house back subject to the first loan. So, they are unlikely to do that. If the second is a purchase money note, the second cannot look to the borrower for repayment. As I said, there is no personal liability on a purchase money loan. If the second was put on the home after closing, however, the second could look to the owner for repayment of the debt. The second could file a lawsuit, get a judgment and collect.
Hopefully, these comments answer your questions.
If you have more questions for Gary Laturno, please leave a comment below or send an e-mail to firstname.lastname@example.org.