Redwood City Bankruptcy: Purchase Money Protection in Real Estate

A very important California state law is California Code of Civil Procedure Section 580b):

“CCP 580b.  No deficiency judgment shall lie in any event after a sale of real property or an estate for years therein for failure of the purchaser to complete his or her contract of sale, or under a deed of trust or mortgage given to the vendor to secure payment of the balance of the purchase price of that real property or estate for years therein, or under a deed of trust or mortgage on a dwelling for not more than four families given to a lender to secure repayment of a loan which was in fact used to pay all or part of the purchase price of that dwelling occupied, entirely or in part, by the purchaser.

Where both a chattel mortgage and a deed of trust or mortgage have been given to secure payment of the balance of the combined purchase price of both real and personal property, no deficiency judgment shall lie at any time under any one thereof if no deficiency judgment would lie under the deed of trust or mortgage on the real property or estate for years therein.”

Essentially, this means that the only recourse a mortgage lender has when a purchaser stops making the mortgage payments is to foreclose on the property; the lender cannot then sue the foreclosed-upon purchaser for any deficiencies. This applies to the property where the lender lives (i.e., the house you bought and live in). It includes repossessed automobile that payments were not made on. In that circumstance, the financer will “repo” the vehicle after 60 days late or so (generally a bit longer, however) and then put the car up for auction. The person will owe the difference between the car value and the auction price. Yet, this is not the case with a home.

However, note that this rule of protection applies only to homes that have not been refinanced (and refinancing includes the now-popular loan modification). In other words, buying a home, pulling money out or renegotiating the terms of the original (purchase money) contract, and then foreclosing could be subject to being sued for the difference between the note value at foreclosure and the price of the home procured at auction. If a person buys a home, never refinances, and sees its value plummet and decides not to want to keep it any longer, the he may walk away from it free and clear of non-tax, legal consequence. This is called a “strategic foreclosure.” Of course, credit will reflect a foreclosure and the ability to secure a new home will suffer greatly. But it is neither legal nor unethical to walk away like that because these terms were negotiated before acted on. The lender puts a cap on how much he would lend on the property. And it is the legislators who wrote this law protecting people’s rights. Note that the protections of CCP § 580b do not apply to property that has been refinanced.

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