Effective January 1, 2011, California first trust deed mortgage holders who consent to a short sale of residential property (up to four units) are prohibited from seeking a deficiency judgment for the difference between the mortgage balance and the proceeds realized through the sale.
This new law was brought about through Senate Bill 931 (Ducheny) which was passed by the legislature in August and approved by the Governor September 30, 2010.
According to the author, the purpose of the legislation was primarily to protect distressed homeowners who have non-purchase money recourse loans on residential property (1-4 units), when the fair market value of the subject property is less than the balance of the first deed of trust. The legislation will make sure that these homeowners do not incur a higher dollar amount of liability after a short sale than they would otherwise have after a foreclosure sale.
The author noted that, under California law, a variety of anti-deficiency protections applied to homes that were sold through foreclosure, but that there were no similar protections available when a short sale occurred. Ironically, this could provide a disincentive to completing a short sale. In some cases it would be financially more sensible to the borrower to allow a home to go to foreclosure and to avoid any deficiency judgment.
But that, in the author's point of view, made for bad public policy. It was, he argued, favorable to have a home sold to a new owner who will upkeep the property as opposed to potentially reverting to the lender at a foreclosure sale.
The provisions of SB 931 do not apply to junior liens. So it is still possible for a 2nd or 3rd mortgage holder to consent to a short sale by releasing its lien, but nonetheless to proceed against the seller for the deficiency between the balance of the note and whatever proceeds the lien holder received from the short sale.
Additionally, SB 931 does allow a 1st trust deed holder to pursue a deficiency after a short sale if the borrower commits either fraud with respect to the sale of, or waste with respect to, the real property that secures the first deed of trust ... .
SB 951 received no registered opposition during the legislative process. However, if similar legislation is introduced with respect to junior liens, it is expected that institutional lenders will be opposed.