C.A.R. Issues Consumer Warning About Legal Loophole in California Mortgage Foreclosure Laws

---

According to the California Association of Realtors (C.A.R.), there is a loophole in California's state law that allows banks to sue foreclosed borrowers for the difference between the mortgage and the property value.

Facing the possibility of foreclosure, California homeowners may be hit with more than just losing their homes.  Due to a loophole in state law, they also can be sued by their lender.  For people who have refinanced a property, even if the money is used for home improvements, there is no protection should the borrower default on a mortgage that's greater than the property's value. Called a "deficiency" liability, under current California law, the lender can sue the former homeowner for the amount of the deficiency even after taking back the property.

C.A.R. is now alerting consumers and has sponsored legislation -- Senate Bill 1178 by State Sen. Ellen Corbett (D-San Leandro) -- to close this loophole.

"Most homeowners have no idea they are personally liable," said C.A.R. President Steve Goddard. "Foreclosure is difficult enough on a family. Getting sued for tens of thousands of dollars after losing your home is much worse.

"During times when Californians are struggling to protect their homes, state government should enact reasonable protections to help people get through what is a very difficult situation," he said. "Senate Bill 1178 strengthens the lending process and protects Californians. Borrowers will be protected from fundamentally unfair lending practices and lenders will be accountable for the quality of loans they refinance."

California has protected borrowers from so-called "deficiency" liability on their home mortgages since the 1930s, but the evolution of mortgage finance requires that the statute be updated.  Essentially, it says that if a homeowner defaults on a mortgage used to purchase his or her home, the homeowner's liability on the mortgage is limited to the property itself. The law has worked well since the 1930s to protect borrowers, ensure the quality of loan underwriting, and allow borrowers brought down by financial crisis to get back on their feet.

Unfortunately, the original law does not extend the protection to loans that refinance the original purchase debt, even if the refinance only was to gain a lower interest rate.  Recent years of low interest rates and aggressive marketing campaigns by lenders have induced tens of thousands to refinance mortgages.  Few homeowners realized that by refinancing their mortgage, they were forfeiting their protections and now are personally liable.

"Lenders have a responsibility to ensure that borrowers understand loan terms and can meet them," Goddard said. "SB 1178 puts in place much-needed consumer protections and deserves swift passage by the California legislature next week."

---