Anti-Deficiency Statutes and the "One Action Rule" Help Protect Already Troubled Homeowners

As is happening today more so than at any other time in California's history (and across the country), borrowers are defaulting on their loans and losing their homes in foreclosure. Luckily, in some cases, a set of Depression-era laws can protect borrowers and soften the blow.

In the early 1900's, after a foreclosure was completed and the bank sold or reacquired the property, the bank could still sue the borrower for the remaining loan balance if the balance exceeded the value of the property. For example, assume a borrower purchased property for $100,000 and obtained a loan for the full amount. Thereafter the property value decreased to $80,000 and the owner stopped making payments. The lender would foreclose on a property (thus obtaining the $80k market value) and then seek a judgment against the borrower for the remaining amount ($20k), known as the "deficiency." In addition to having already lost their home, this additional debt often pushed borrowers into poverty.

In response, California enacted "anti-deficiency statutes", the One Action Rule and other rules which protect defaulting borrowers by preventing lenders from seeking the deficiency for certain loans or in a second action (the foreclosure being the first). In general, once the lender has reacquired the property that secured the debt, no further action can be taken against the borrower. Typically, these protections only apply to residential property that the borrower actually occupied. They do not apply to loans on vacation, investment, or commercial properties. Also, the statutes only apply to "purchase money loans", i.e., loans that are used to actually acquire the property. Examples of non-purchase money loans (to which the statutes do not apply) are refinances, home equity lines of credit and home improvement loans.

In addition, per the One Action Rule, the lender can only maintain one "action" against the borrower either a judicial foreclosure (i.e., filing a lawsuit to foreclose on the property) or a non-judicial foreclosure (i.e., exercising the "Power of Sale" contained in the Deed of Trust). If a non-judicial foreclosure is sought, the lender can only foreclose and not thereafter seek a deficiency judgment regardless of the type of loan. If a judicial foreclosure is sought, the lender can foreclose and seek a deficiency judgment, unless the loan was a purchase money loan in which case the foreclosure is treated as a sale back to the lender. However, because judicial foreclosures are much more uncertain, time consuming and costly, lenders rarely pursue them, even if it means losing their right to a deficiency judgment against the borrower.

Finally, as is always the case, there are tax implications to the borrower a foreclosure sale with this type of loan (i.e., a secured loan) may generate capital gains or losses and foreclosure of a non-purchase money loan may produce cancellation of debt income.