Protection for Arizona Homeowners Who Default on Mortgage Loans Secured By Their Home

In the current Arizona real estate market there is confusion about a homeowner's liability to the lender for a home that is "upside down," i.e., the home is worth less than the amount of the loan on the home. The following are five general observations of current Arizona real estate law that should be helpful in clarifying this issue.

1. Lender Can Sue Borrower Only if Non-purchase Money Loan.

If a loan was used to purchase the home, the loan is a non-recourse loan. In other words, the homeowner has no personal liability for the loan, unless there is excessive damage such as vandalism or flooding, i.e., "waste" to the home. Therefore, the lender's only recourse after loan default is to foreclose on the home, and the lender cannot waive foreclosure and sue to collect the amount of the loan. If, however, the loan was not used to purchase the home, e.g., a home equity line of credit ("HELOC"), the lender can waive foreclosure and sue to collect the amount of the loan. For example, if the homeowner after purchasing the home borrows $50,000 under a HELOC, the lender can waive foreclosure of the home and instead file a lawsuit in civil court to collect on the $50,000 promissory note.

2. No Foreclosures by Second Mortgages.

In the current real estate market a second mortgage loan, whether a purchase money loan or a non-purchase money loan such as a HELOC, generally will not foreclose. The reasons are that the second mortgage lender may then have to pay off the first mortgage loan or lose the property to foreclosure; there is generally no equity in most homes subject to foreclosure in this current real estate market; and, as discussed below, the second mortgage lender would not be able to pursue any deficiency claim against the owner of the home. (In prior "boom" years, however, a second mortgage lender would occasionally foreclose on a home with some equity, and then try to "flip" the home quickly to make a profit before the first mortgage loan foreclosed.)

3. No Deficiency Allowed After Foreclosure of Home.

If there is a foreclosure of the home by the lender, whether the loan was a purchase money loan, i.e., a loan used to buy the home, or the loan was a HELOC or other non-purchase money loan, the lender will never have a claim for deficiency against the homeowner.

This protection applies even if the homeowner is an investor or a homebuilder. In interpreting the anti-deficiency statutes the Arizona appellate courts have consistently ruled that, while the intent of the legislature in originally passing the anti-deficiency statutes may have been to provide for protection only for primary residences, i.e., "mom and pop" homeowners, the broad language of the anti-deficiency statutes also provides protection for investors and homebuilders.

4. Protection Unclear if "Cash Out" Refinancing.

If there is a refinancing of the original purchase money loan on the home, the anti-deficiency statutes will still protect the homeowner from a deficiency after foreclosure of the refinancing loan. If, however, there is a "cash out" refinancing, i.e., at the time of refinancing the original purchase money loan is paid off and the homeowner receives additional cash, the law at this time is not clear, especially if the "cash out" was not used to improve the home. For example, if the homeowner buys the home with a $100,000 loan and three years later refinances with a $150,000 loan and takes $50,000 "cash out" and buys a boat, the lender may be able to sue the homeowner for this $50,000 "cash out."

5. No Liability for Short Sale Difference Unless Agreement.

If the lender approves a short sale by the seller, the short sale "difference" (not technically a "deficiency" after a foreclosure sale) is waived by the lender after the lender releases the loan in order for the seller to close the short sale to the buyer. If the loan is released, the seller has no liability for the short sale difference unless the seller agrees to the lender's requirement to pay back the short sale difference. An example is a home worth $60,000 and the loan is in the amount of $100,000. The lender approves a short sale of $60,000 to a buyer; the short sale difference is then $40,000. After the short sale to the buyer closes, the seller has no liability to the lender for this $40,000 short sale difference unless the seller signs a promissory note or otherwise agrees to pay this $40,000 short sale difference to the lender.

Due to the increased number of foreclosures and short sale foreclosures in Arizona, this area of the law is evolving. In 2010 there will probably be new Arizona appellate court decisions and new Arizona legislation.