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A Deficiency Judgement? In Arizona? Not Likely.

Hello again!

Have clients asking you about short sales? I know I certainly do! In fact, it’s become a big part of my business. In fact, I am conducting short sale negotiations for 3 different REALTORS, as well as 5 different clients. Unfortunately, a lot of questions have arisen lately about Arizona’s Deficiency Statutes regarding foreclosure. I say “unfortunately” because I feel somewhat less than qualified to definitively answer these questions. Greater legal minds than mine (and mine is decidedly NOT legal) will be required to put the issue to rest. I will, in spite of the danger of blatantly misrepresenting the facts, case law, and statutes, attempt to answer one (NON-) simple question:

“If I do a short sale, or my property is taken from me by foreclosure, can the bank ‘come after me’ for the difference between what the property eventually sells for, and what I owe them, including sale costs, legal fees, etc?”

First, let me point the reader in the general direction of actual legal minds on this issue. Here is a rather esoteric treatise on the subject of getting sued for a deficiency judgement. Very good read, and fairly definitive on the issue.

Here is another article, that is more user-friendly on the same subject. Now, because I have a public education, and am somewhat literate, I will attempt to provide a synopsis of the above:

In Arizona, there are two types of “notes” given for real property: a “Deed of Trust” or a “Mortgage”. Despite the common parlance of the term “mortgage,” most people in most states do not actually have Mortgages. They have Deeds of Trust. I won’t go into the differences here, but suffice to say that a Deed of Trust has three parties to the agreement, and an actual Mortgage has only two. Actual mortgages are very uncommon in most states.

Now, the remedy of a lender for a home in default depends on what type of note was used to secure the property. If there is a true mortgage in place, the lender must sue in civil court in a process known as “judicial foreclosure.” The particulars of a judicial foreclosure are not completely relevent to our discussion here, but here are a few key points.

1.) The legal fees associated with a judicial foreclosure action are substantial.

2.) A jucial foreclosure takes more time than “the other method” (hold on there. . .).

3.) A lender may sue for a deficiency judgement with a judicial foreclosure, but only in the case of non-purchase money loans. (A “purchase money loan” is one that is applied to the purchase of real property. A “non-purchase money” loan is money you pulled out of your home to buy “stuff”.

Herein lies a very poignant distinction. If you got a line of credit, and spent all the money on a new boat, fancy clothes, and a new haircut, the lender can indeed sue you for that money. HOWEVER, they will have to use the process of judicial foreclosure to do it, which I have already explained is a lengthy and costly process. In real life: probably too expensive for the lender, with very little likelihood of getting money back from someone who is “insolvent” to begin with.

If the note used to secure the property is the much more common Deed of Trust, the property will most likely be subject to a “Trustees Sale,” in which a notice is posted that the property will be sold to the highest bidder on the courthouse steps. If this happens, there is no recourse for a lender to “come after” the homeowner for money. Now, a lender, who is party to a Deed of Trust, may also use the process of judicial foreclosure to take your house away. Any yes, this does give them the right to attempt to get a deficiency judgement against the borrower. Does this happen often? No. Why? For the reasons mentioned above: it’s expensive, and time consuming.

Another option for a lender is to “forego” their interest in the home, and sue the borrower directly for the money owed to them. All of it. Lenders very rarely do this however, for the reasons stated above: it is expensive and time consuming; more importantly, if a borrower is going into foreclosure, there is a pretty good likelihood that the borrower has no money to “go after.” Also, in the landmark case of Baker v Gardner heard before the Arizona Supreme Court in 1988, the justices hold forth in the Holding & Conclusion that “. . .the legislature’s objective in enacting [its anti-deficiency statutes] was to abolish the personal liability of those who give trust deeds encumbering properties of two and one-half acres or less and used for single-family or two-family dwellings. . . The holder of the note and security device may not, by waiving the security and bringing an action on the note, hold the maker liable for the entire unpaid balance.”

So, can you be sued for a deficiency on your mortgage? Who knows! Go ask your attorney.

Disclosure: I am not an attorney, and I do not play one on TV or on the internet. I am simply an inquisitive idiot with a penchant for holding forth opinions. Have legal questions regarding your specific circumstances? Contact competent (how do you test for that?) legal counsel.

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    8 Comments so far

    1. Brian Brady March 8th, 2008 9:40 am

      Nice synopsis, Allen. I was reading some background for California and discovered similar practices here. This will be an excellent resource for people from AZ who ask about this.

    2. [...] A Deficiency Judgement? In Arizona? Not Likely., by Allen Butler. [...]

    3. jeff April 1st, 2008 1:29 pm

      Sued for deficiency in a foreclosure? The Arizona statutes “clearly” state that properties of two and one-half acres or less and used for single-family or two-family dwellings; the lender cannot bring a deficiency suit. I asked my real estate attorney, and he concured. Caviot: Provided the mortgage has a deed of trust (which is 99% of the time), and that the money that was borrowed was used to purchase or re-fi the secured real estate (not cash out to buy other stuff)……PERIOD.

    4. Loren Hotz June 2nd, 2008 11:39 am

      I am a property owner in Arizona but I practice real estate here in Colorado.

      Obviously, foreclosure laws vary tremendously state-by-state. We do not have the type of state laws that protect borrowers from deficiency judgments. In fact, I had clients who have had deficiency judgments as a result of property that was foreclosed.

      Here, lenders use the threat of deficiency judgments to extract the most funds as possible on short payoffs of mortgage loans. That tactic is often successful. It it also can force a borrower to have to declare bankruptcy.

      It would seem that Arizona would have higher risks associated with home loan lending than Colorado because your foreclosure law is more pro-consumer. But, the cost of money they are is almost identical to the cost of money in Colorado. That would seem to be a good argument against the notion that protecting the consumer would lead to higher rates.

    5. Nouveau Riche June 25th, 2008 2:24 am

      I didn’t know that the foreclosure laws vary so much from state to state. Can anyone tell me what are rules in Texas?

    6. Andrew Reichek July 18th, 2008 1:38 pm

      Hi Allen,

      These processes are so time consuming for both the lender and the borrower. The lender just wants to get as much money as possible out of the house. And they know the borrower probably does not have any money. Its normally just best for the lender to move on rather than litigate the entire process. Thanks for the great information.

    7. San Antonio Lawyer September 3rd, 2008 3:51 pm

      Nouveau Riche – I live in Texas, but I am not familiar with the laws. I would check yahoo answers if I were you.

    8. Robert September 20th, 2008 9:32 am

      It sounds like unless the lender has deep pockets this business can be very costly in times like these. If the home buyer leaves or is forclosed upon it looks as though the lender will lose. Can they really afford to go throughout this legal process and pay the legal fees. It sounds like a waste of time.