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California Deficiency Balance

Our deficiency balance for our first mortgage was forgiven. Our equity line of credit was not. Is this legal? Is so, now what?

We short sold our California house at the end of 2008. We had an equity line of credit on the house and got a 1099-C from the bank for that tax year. At this time we are getting bills from a creditor company on that equity line of credit amount. Our bank sold this line to a creditor after we short sale our house. When I checked our credit report a few days ago, it was stuck showing as a balance on our credit report. What should we do at this time? Are they allowed to bill us after we short sale a house?

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Highlights

  • Review how a short sale can affect a second mortgage balance.
  • Examine the tax implications of a short sale.
  • Negotiate with the mortgage holder, if the loan becomes an unsecured loan.

Editor's note: The California legislature has changed the deficiency balance law twice since this was written originally. See the notes below to learn more about the changes to Calif. Civil Procedure §580e.

It appears the 1099-C you received was for the short-sale of the home and included the first mortgage (deed of trust), and not the equity line of credit. Each state has its own laws regarding collection of deficiency balances on home sales.

If the property was your primary residence, you are almost certainly subject to the Mortgage Forgiveness Debt Relief Act, which as its name implies, erases the taxes related to forgiven mortgage debt.

Short Sale

In a short-sale, the property owner and lender may choose to do a short sale on the home to avoid foreclosure. In a short sale the lender agrees to accept less than the balance owed on the mortgage at the time of sale. The deficiency balance is forgiven, typically, although there are no hard-and-fast rules in this regard. However, this does not always apply to the second mortgage or line of credit.

Some mortgage companies are asking borrowers to agree to accept liability for the deficiency balance. The lesson here is if you are considering either a deed-in-lieu-of-foreclosure or a short sale you must review the terms and conditions carefully and make certain you understand whether the deficiency balance is forgiven.

Deficiency Balance in a Foreclosure

A deficiency balance arises if the sale proceeds are not sufficient to pay the entire balance owed on all secured loans. The consumer may be liable for the difference. Some lenders may forgive a deficiency balance, but not all do. California consumers who default are protected, in some cases, by the state’s anti-deficiency laws. In California, if a consumer has not refinanced a purchase money loan, then the creditor for the first mortgage (called a deed of trust in California) may not sue for the deficiency balance. However, line of credit loans and non-purchase money second mortgages (deeds of trust) are not covered by California’s anti-deficiency laws.

Suing for a Deficiency Balance

Generally speaking, it is unsound economically for an original creditor to sue for the deficiency because the debtor usually does not have the financial resources. After all the debtor would not have defaulted if they could have afforded the payments, in most cases.

Original creditors rarely choose to litigate a deficiency balance case. Instead, the original creditor will sell (also called assign) a deficiency balance account to a collection agent. Typically, unsecured debts such as deficiency balances, credit card debt, medical bills, and payday loans are sold for pennies on the dollar. Despite the bargain-basement price of a collection account, a collection agent had the legal right to collect the face value of the account. If a creditor files a lawsuit and wins, it may be able to obtain a judgment, which could lead to wage garnishment, bank levies, and/or property liens, depending on the defendant’s state laws.

Consult with an attorney in your state to determine if the creditor has the right sue you in your circumstances, and if so, what the consequences may be. You mentioned you reside in California. See the Bills.com resource California Collection Laws to learn more about your rights and potential liabilities. Editor’s note: California SB 931, which was signed into law September 30, 2010 and became effective January 1, 2011, outlaws a deficiency judgment under a note secured by a first deed of trust or first mortgage for a short sale. SB 458, signed by the governor July 11, 2011, forgives all debt, including second mortgages and deeds of trust, after a short sale. A lender may not require a homeowner to waive these rights contractually.

Negotiate

Following the foreclosure, the second mortgage or line of credit became an unsecured debt. Negotiate with the creditor in an attempt to reach an out-of-court settlement on the debt. If necessary, enroll the debt in a debt negotiation program. (Go to the Bills.com debt relief savings center for a no-cost quote.) Another option is to negotiate the debt yourself. Consider offering the creditor 10 cents on the dollar for a lump-sum settlement.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com

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17 Comments

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  • KS
    Jan, 2012
    Kandee
    Reno, NV
    We sold our house in Ca. a few years ago. We carried a second on it. The couple were making payments for awhile then they stopped. We tried to work with them and get something. So for the last 1 1/2 yrs. nothing. The balloon payment is due March of this year. We just found out they are short selling the house. How can we get our money from them?
    0 Votes

    • BA
      Jan, 2012
      Bill
      Consult with a California lawyer who has experience in real property law immediately. I realize a lawyer's time is not cheap, but not learning your rights and what tactics and strategies you can take to preserve your rights is expensive indeed.

      Ask your lawyer if it would be a wise tactic to file a breach of contract action now against the borrower. Do so now, because the California statute of limitations on contract debt is approaching.
      0 Votes

  • AB
    Nov, 2010
    Anna
    My comments go out to Rick date 9/10/10 if you are still reading these blogs I would like to know how you pleaded your case with Chase? We did a short sale with Chase and they came after us for the balance on our second too. They want $115,000. How did you get them to write off the balance on your loan? We don't trust them but know we may have to pay something. Can you help?
    0 Votes

  • BA
    Sep, 2010
    Bill
    If the junior deed of trust was really a purchase money loan that was never refinanced, I would ignore Real Time Resolutions' offer for the time being. If you allow a foreclosure, then I would ignore Real Time Resolutions altogether because you are protected by California's anti-deficiency statute. If, on the other hand, you do a short sale, then you will want to reach a settlement agreement with Real Time Resolutions. You did not ask, but I really dislike their terms and conditions, especially about rescinding the offer upon review of the property sale. They really want to have their cake and eat it too.
    0 Votes

    • KR
      May, 2011
      Katherine
      Pleasanton, CA
      I got Boa first lender to accept short sasle offer plus 3K to 2nd lender. Got buyer to put 14k to give 2dn lender,(refinanced loan). Now per law I n=have a 2nd collection agency taking charge ..becuase after 6 months CHASE change collection company if they got no settlement. So this new Collector is so agressive and heat things up, do not want those 18k to settle. He wants 39k. Property was 600k selling price 240 and 2nd loan was 189K. I don't have 11k to pay, so we complete the 39K he is asking. And off course they have to agrre to give the 1099C if not I would have problem unsolved and they can come back later. pLease "Bills" am I protected by California LAw on 2nd defficiency?
      0 Votes

    • BA
      May, 2011
      Bill
      California's anti-deficiency law for short sales protects consumers with first mortgages or deeds of trust by disallowing collections of deficiency balances. It does not protect consumers who have second mortgages or deeds of trust.
      0 Votes

    • KR
      May, 2011
      Katherine
      Pleasanton, CA
      I missed that 240K it's current value of property. I meant that if I let the property go to Foreclousure does second lender can ask for Deficiency Balance?...
      0 Votes

    • BA
      May, 2011
      Bill
      In California, if a mortgage or deed of trust is a purchase money loan, and was never refinanced, then it is subject to California's anti-deficiency laws.

      Regarding yoru question, was the second ever refinanced? If the answer is yes, then the second mortgage/deed of trust servicer has the legal right to collect the deficiency balance. If the answer is no, then the servicer has the right to collect the deficiency balance.
      0 Votes

  • 35x35
    Sep, 2010
    Michael
    Good morning. I am in the process of short selling my house in Southern California. I have an 80/20 loan. My question is with regards to the second mortgage. It is a purchase money loan. It was owned by BOFA the holder of the 1st note but was then sold to Real Time Resolutions which is a debt collector out of Dallas that purchases bad debt and tries to collect on the whole amount owed. On their approval they state the following: Your offer of $3,000.00 in the form of a Cashier's Check/Title Company Check will be accepted to release the lien associated with the above referenced loan. However, Real Time Resolutions, Inc. reserves the right to amend or rescind this offer upon review of the final settlement statement or HUD sent to us within 48 hours of closing. Moreover, Real Time Resolutions, Inc. reserves the right to pursue loan contract or tort claims associated with the origination or purchase of the above referenced loan or property or with the settlement, such as fraud, negligence, perjury or any other claims. The funds must be received in this office within 30 days from the date of this letter. Real Time Resolutions will pursue the collection of the remaining deficiency balance of $72,035.60 and will expect you to make immediate contact to establish a reasonable payment plan for the balance. Real Time will continue all collection efforts on this account including the reporting of your account to the credit bureau monthly until all obligations have been satisfied. I have sent this to an attorney and he has told me that they are trying to change this debt from purchase money secured debt to a personal debt and he recommends we let the house go to foreclosure. Please advise as to what if any remedies we may have to short sale our home? Thank you, Michael
    1 Votes

    • WK
      Apr, 2011
      William
      Palm Springs, CA
      Hi Micheal, I live in S.Cali as well. Finished the short sale with BOFA anf RTR.Thought I was thru and now have the same problem you did. What happened with your second? Thanks Will
      0 Votes

    • JB
      May, 2011
      Jerry
      Sacramento, CA
      I completed a short sale in August 2010. I had a 80/20 loan as well with Indymac/Greentree in which Indymac agreed to everything with the short sale while Greentree only dragged things. Greentree finally agreed to release the lien but only if instead of the 3k being given to them by the first lender after the short-sale, a total of 5k was paid off to them. The first lender said all they would get from them was $3k, and I did not have the money; however, the buyer really wanted the house, so he paid the additional $2k out of pocket to Greentree (don't know if that was communicated to the first lender). In the final letter Greentree released the lien but then indicated that it would continue collection efforts on the remaining 50k. The equity line of credit with Greentree was for the sole purpose of purchasing the house and was originally made with another lender. At the time of the short sale I was told that neither the 1st or 2nd loans were recourse loans, as they were both for the purchase of the house and were made at the same time. However, Greentree has now began trying to collect on the deficiency. I've directed them to CA civil code 580 and have had an my attorney send them a letter regarding CA law, but they keep calling me and insist that "those type of laws" do not apply to short sales. And, that though I did not sign anything remotely similar to a promissory note at the time of the short-sale, that I am still obligated to pay the deficiency. Since the short sale already took place, and I have no paperwork to show that I did/did not agree to pay the deficiency is there anything I can do? Am I still protected under by California's anti-deficiency statute even if the short-sale was completed August 30, 2010? I really thought we had reached a settlement agreement when an extra $2k were paid off to them. Thank you so much for your help.
      0 Votes

    • BA
      May, 2011
      Bill
      The key piece of evidence here is the contract you signed for the short sale. You must find a copy of this document for anyone to decide if the $2,000 paid by the buyer released you from liability on the deficiency balance. Until you have this document, you and the creditor are just playing a "yes you do, no I don't" game that is just spinning everyone's wheels and not advancing the negotiations.

      As of January 1, 2011, the collection of deficiency balances for first mortgages and deeds of trust in California is not allowed. Before then, collecting a deficiency balance on a short sale was legal.

      Consult with a California lawyer who has experience in real property law and show him or her a copy of the short sale you signed. He or she will advise you accordingly.
      0 Votes

    • TL
      May, 2011
      Tyler
      San Diego, CA
      I did this! I did a shortsale on my investment property where RealTime had the 2nd, I signed the Lien Release letter to get the deal closed and then realized it was a promissory note. If I would have let the property go to foreclosure, the 2nd would have gone with it, now I still owe Realtime Solutions for the $97,000 balance! Trying to work out a settlement with them now. If anyone else is doing a short sale make sure and have the buyer kick in to payoff the 2nd. This is what my Listing agent should have set-up. Don't make my mistake.
      0 Votes

  • BA
    Sep, 2010
    Bill
    Thank you for sharing your scenario. Make sure to include any forgiveness of debt on the tax return for the year the debt was forgiven or to use the IRS Form 982, if it applies. The Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, helps a taxpayer avoid having to declare the forgiven debt as income. Consult with your tax professional to see if you qualify to use the Form 982. Also, remember that a taxpayer has only until October 15th of the year that the return is due to file the Form 982. If a taxpayer files after that date, the Form 982 will not be accepted.
    0 Votes

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