Anti-deficiency statutes

Deficiency Claim Likely Moot

Question: Four years ago, we bought a lot in north Scottsdale to build our dream home. We got a construction loan and began the construction of the home. Due to marital problems, however, we never completed the home, and we tried without success to sell the home partially completed. Our construction lender has now foreclosed on the partially completed home and has filed a lawsuit against us for the $220,000 deficiency after the foreclosure sale. We went to a real estate attorney who said that, because the home was only partially completed, the anti-deficiency statutes do not protect us from personal liability for this $220,000 deficiency. Is the attorney right? Are we personally liable for this $220,000 deficiency, or do we have the protection of the anti-deficiency statutes even though our home was only partially completed?

Answer: The anti-deficiency statutes generally protect homeowners from any deficiency claim after foreclosure if the home is located on 21/2 acres or less and is being “utilized as a dwelling.” There has always been controversy as to what “utilized as a dwelling” means. For example, if you spend one night in the home, is the home being “utilized as a dwelling?” The Arizona appellate courts in general have broadly interpreted the anti-deficiency statutes to protect owners of homes; Arizona is one of only a few states that prohibits a deficiency against an investor after foreclosure of an investor-owned home. In another broad interpretation of the anti-deficiency statutes, the Arizona Court of Appeals recently ruled in favor of a homeowner with a partially completed home such as yours. The appeals court reasoned that the homeowner intended to live in the home upon completion. In other words, the partially completed home was being “utilized as a dwelling.” Therefore, the construction lender could not sue the homeowner for a deficiency after foreclosure. The construction lender has appealed this decision to the Arizona Supreme Court, so your attorney should keep you informed of any adverse decision that would make you liable for the $220,000 deficiency.

Court of Appeals Upholds Anti-Deficiency Protection for Vacation Homeowners

By: Adam D. Martinez, Esq.

In a major victory for vacation homeowners, the Arizona Court of Appeals ruled on July 17, 2012, that the protection of Arizona’s anti-deficiency statutes extended to the owners of a vacation home, even though the owners only owned a fractional interest in the home, and even though the owners could only use the home for 28 days or less each year. The owners were represented by Combs Law Group real estate attorney, Adam Martinez.

In 2006, the owners obtained a loan from a lender, Independent Mortgage Company, to purchase a 1/10th interest in a single-family home located in the Sedona private luxury development, Seven Canyons. The owners secured the loan with a deed of trust on the home. The owners defaulted on the loan, and the lender foreclosed on the owners’ interest in the home. After the foreclosure, the lender sued the owners for the remaining balance of the loan, i.e., the deficiency. The owners argued that even though they only used the home occasionally while on vacation, their use of the home was limited to a single family “dwelling” and that the anti-deficiency statutes do not preclude fractional ownership interests or vacation use from its protection for single family “dwellings.” The lender argued that because the owners only had a fractional interest in the home and could only use the home for up to 28 days out of the year, they did not use the home as a single family “dwelling” and were not entitled to deficiency protection. The trial court ruled in favor of the owners and the lender appealed the trial court’s ruling to the Arizona Court of Appeals.

Upholding long-standing Arizona law that provides that investment or vacation homes are included among the types of homes subject to Arizona’s anti-deficiency statutes, regardless of the length of use, both the trial court and the Arizona Court of Appeals disagreed with the lender and ruled that the owners qualified for protection under Arizona’s anti-deficiency statutes because the statutes do not exclude fractional interests in vacation or investment homes that otherwise qualify for protection, nor do the statutes require occupancy for a certain length of time. See Arizona Court of Appeals Case No. 1 CA-CV 11-0301. Specifically, the Court of Appeals stated that Arizona’s anti-deficiency statutes do not require that the home be a permanent or normal place of abode, and that sporadic vacation use still constitutes use as a “dwelling.”

The Court of Appeals stated that only the legislature could change Arizona’s anti-deficiency statutes to preclude vacation homes or fractional interests from deficiency protection and that Arizona’s anti-deficiency statutes have remained unchanged for almost 30 years.

Can a Lender Sue a Homeowner for Deficiency?

Question: Recently in a column you stated that, after a mortgage lender forecloses on a home built on 2 ½ acres or less, under Arizona Real Estate law the mortgage lender is generally prohibited from suing the homeowner for any money lost by the mortgage lender on the loan. Is this protection limited to a homeowner’s principal residence, or does this protection also apply to investors who own homes? Does this protection apply to foreclosure of second mortgages like a home-equity line of credit? Does this protection apply to a vacant lot upon which a home will ultimately be built?

Answer: Your questions could be the basis for an all-day seminar on foreclosure law. The following are brief answers.

The anti-deficiency protection after foreclosure is not limited to a homeowner’s principal residence. Investors who own homes in Arizona also have anti-deficiency protection after foreclosure.

Protection from personal liability for homeowners is limited to mortgage loans used to purchase the home. In other words, a purchase money mortgage lender cannot sue for a deficiency after foreclosure, nor file a collection lawsuit for the amount of the loan.

If a second mortgage loan such as a HELOC was not used to purchase the home, the second mortgage lender is not required to foreclose but can file a collection lawsuit for the amount of the second mortgage loan.

There can never be a deficiency after a foreclosure of a home. In the rare circumstance when a second mortgage lender forecloses on the home, the anti-deficiency protection applies and the second mortgage lender cannot sue for a deficiency.

Finally, a loan used to purchase a vacant lot and construct a home does not have the protection of the anti-deficiency statutes until the home is actually built and occupied — that is, “utilized as a dwelling.”

Short Sale Units Worth a Try, Deed In Lieu of Foreclosure Isn’t Likely

Question: We own three four-plexes in East Phoenix secured by one loan. When we purchased these three four-plexes seven years ago, we knew that the neighborhood was not a good one, but we believed that the neighborhood would improve. To the contrary, the neighborhood has continued to deteriorate. The loan balance now greatly exceeds the value of the three four-plexes, and we can no longer make the loan payments. Our lender has refused to accept deeds in lieu of foreclosure from us. The lender wants us to do a “short sale” of the three four-plexes, but we would still have to pay the amount of the remaining loan balance. If the lender continues to refuse to accept deeds in lieu of foreclosure, can the lender foreclose on the three four-plexes and demand payment of any deficiency?

Answer: Yes. First, a lender is never under an obligation to accept a deed in lieu of foreclosure from the borrower. In fact, lenders rarely accept deeds in lieu of foreclosure. Second, if you do not make the loan payments, the Arizona real estate law of anti-deficiency statute will not protect you from a deficiency judgment after the foreclosure sale because Arizona’s anti-deficiency statute only applies to loans secured by a single-family home or duplex, not a four-plex. Therefore, you should try to do a short sale, and negotiate with the bank for an amount that you would still owe the bank. If your financial situation is poor, the bank may agree to settle for significantly less than the amount of the remaining loan balance. If you do not agree with the bank and close a short sale, the bank will eventually conduct the foreclosure sale and file a lawsuit against you for the amount of the deficiency. The bank must file any deficiency lawsuit within ninety days after the foreclosure sale.

After Mortgage Default Lender Can Collect Against Debtor’s Assets and Garnish Wages

Question: Four years ago we purchased a lot in the Arrowhead area of Peoria for $300,000. We paid a $20,000 cash down payment with a mortgage of $280,000. Although it has been difficult, we have kept the payments current on this lot until five months ago. Our neighbor is a real estate broker, and says that the lot is worth $80,000. Because of the mortgage default, the mortgage lender has now scheduled a foreclosure sale in three months. My husband and I both work for a large insurance company, and we are terrified that after the foreclosure sale the mortgage lender will still try to collect on the mortgage loan by garnishing our wages. How much will we owe the mortgage lender after the foreclosure sale? Is there a time period for the mortgage lender to collect against us?

Answer: After the foreclosure sale the mortgage lender will probably have a deficiency claim against you for $200,000 ($280,000 loan minus $80,000 value of the lot). The mortgage lender then has ninety calendar days to file a collection lawsuit against you for $200,000. Unless you can prove that the lot is worth more than $80,000, i.e., “battle of appraisers,” the mortgage lender will get a judgment against you for $200,000, plus court costs and attorney’s fees. After getting this judgment, the mortgage lender can collect against your assets, including garnishing your wages. Any garnishment of wages, however, is generally limited to 25% of your net paycheck.

Note: The anti-deficiency statutes protect homeowners from any personal liability after the foreclosure sale on loans used to purchase a home, but do not protect owners of vacant lots.

Anti-Deficiency Does Not Protect Owners of Commercial Properties

Question: The loan on our small office building in Gilbert is $850,000. The bank has approved a short sale of $700,000 to a buyer from California. As a condition of approval, however, the bank is requiring us to sign a promissory note to pay the $150,000 short sale deficiency in monthly payments over three years. The bank says that, if we don’t agree to make these payments, the bank will simply do a short sale foreclosure and sue us for the $150,000 deficiency. The bank knows that we are collectable because they have our loan application which lists our personal assets. We consulted with an attorney who said that the anti-deficiency statutes don’t protect owners of office buildings. Should we let them do the short sale or just let the office building go into foreclosure?

Answer: First, the lawyer that you consulted is correct. The anti-deficiency statutes do not protect owners of office buildings after foreclosure; and only protect homeowners that own a home located on 2 ½ acres or less that is utilized as a dwelling. Second, I would recommend that you close the short sale transaction because that will “stop the bleeding.” If there is no short sale, the bank is under no obligation to immediately institute foreclosure proceedings, and many banks are postponing foreclosure sales indefinitely because they don’t want to have to pay the property taxes, association dues, repair/maintenance, etc. In other words, if the foreclosure is not held for another year, the value of your office building could decrease to $600,000 with a deficiency of $250,000. Third, after the short sale transaction closes, if you have available funds you may be able to negotiate a one-time cash payment for less than the $150,000 promissory note.

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