Sedona AZ Real Estate Foreclosures: Top Ten Legal Issues

No Deficiency Allowed After Foreclosure of Home
If there is a trustee’s sale 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 home equity line of credit (“HELOC”), or other non-purchase money loan, the lender doing the foreclosure will never have a claim for deficiency against the “homeowner.” Note: after the foreclosure of the home by the first mortgage, a HELOC lender in second position can still sure the borrower for the amount of the HELOC debt. See #3 below.

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 the 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.

This protection is only available if the “home” is a single-family or duplex, is on 2 ½ acres or less, and is utilized as a dwelling.

Although the homeowner may have no liability for a deficiency after foreclosure, the homeowner could still have personal liability after foreclosure for excessive damage to the home such as vandalism or flooding, i.e., “waste” to the home.

If not a home, the lender is entitled to file a deficiency lawsuit within 90 days after the foreclosure sale against the owner of other real property such as land or an office building. For example, if a lot has a loan of $200,000, but is worth only $50,000, the lender can file a lawsuit after the foreclosure sale to collect a deficiency lawsuit of $150,000; “battle of appraisers” usually results in settlement before trial.

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, will never 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 above, the second mortgage lender would not have any deficiency claim against the owner of the home. (In prior “boom” years, however, a second mortgage lender would occasionally foreclose on the home, and try to “flip” the home quickly to make a profit before the first mortgage loan foreclosed.

Lender Can Sue Borrower if Non-Purchase Money Loan
If the loan was not used to purchase the home, e.g., HELOC, the lender can waive foreclosure of the deed of trust and sue on the promissory note to collect the amount of the non-purchase money loan. For example, if the homeowner after purchasing the home borrows $50,000 under a HELOC, the lender can waive foreclosure of the deed of trust, and instead file a lawsuit in civil court to collect on the $50,000 promissory note. If, however, the loan was used to purchase the home, the loan is a non-recourse loan, i.e., the homeowner has no personal liability for the loan. Therefore, the lender’s only remedy on a delinquent loan used to purchase the home is to foreclose on the home, and the lender cannot waive foreclosure of the deed of trust and sue on the promissory note to collect the amount of the loan.

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.”

Anti-Deficiency Statutes Unchanged
Although there was much legislative activity this year, the “bottom line” is that the Arizona anti-deficiency statutes (primarily A.R.S. §33-814 (G)) currently afford the same protection to homeowners that has existed since the enactment of the Arizona anti-deficiency statutes more than 30 years ago. In the 2010 legislative session, however, the banking industry will probably propose legislation to amend the protection of the anti-deficiency statutes. One proposed amendment currently being discussed would provide that a builder of a “spec” home, i.e., the builder never intends to live in the home, will be liable for any deficiency after the foreclosure sale. The reasoning is that the builder of a “spec” office building does not have the protection of the anti-deficiency statutes so why should the builder of a “spec” home have such protection?

Rights of Tenants After Foreclosure
New federal law protects residential tenants.

If federally-related loan (at least 95% of all loans), the tenant after foreclosure is entitled to stay in the home until expiration of the lease term.

Two exceptions to new federal law authorize termination of lease after foreclosure with 90 days notice.

1. Month-to-month tenancy.
2. If bank sells to buyer who will use as primary residence.

If not federally-related loan, e.g., private lender or seller carry back, state law requires only five days notice after foreclosure and then eviction in Superior Court of the tenant under A.R.S. §12-1173.01; similar to eviction procedure against owner of home after foreclosure.

Commercial tenants have no protection after foreclosure, unless non-disturbance language or similar language in commercial lease.

No Liability For Short Sale “Difference” Unless Agreement If the home is “upside down” and the lender approves a short sale by the seller/borrower, the short sale “difference” (not technically a “deficiency”) is waived by the lender after the lender releases the loan in order for the seller/borrower to close the short sale difference unless the seller/borrower specifically 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/borrower should have no liability to the lender for this $40,000 short sale difference unless the seller specifically agrees to pay this $40,000 short sale difference to the lender, e.g., signs $40,000 promissory note.

If seller does not agree to lender’s requirement, e.g., payment of short sale difference, the seller can cancel contract with buyer because of an unfulfilled contingency. If seller agrees to repayment, however, then seller is bound; seller must read lender approval documents carefully. Notes: Need short sale approval from both lender and any private mortgage insurer, e.g., MGIC.

Cancellation of Short Sale While Waiting on Lender Approval
Buyer can cancel at any time prior to lender approval (and after seller agrees to lender’s terms of approval.)

Seller required to wait reasonable time before cancelling, even if seller receives a much better offer or seller no longer wants to move;
 Reasonable time could be four to six weeks to six months after submission to lender; “lawyer’s dream.”

Listing broker should discuss with seller at time of contract if seller wants some right of cancellation; suggested language: “If seller’s lender does not accept short sale purchase contract within sixty (60) days, seller may cancel purchase contract.”

Listing Broker and Buyer’s Broker Not Required to Reduce Commission if Demanded by Lender
A.A.C. R4-28-1101 (D) prohibits commission disputes with another licensee from affecting a transaction, but does not require either the listing broker or the buyer’s broker to reduce the agreed compensation.

Fannie Mae Announcement 09/03 prohibits Fannie Mae lenders from reducing commissions in short sales.

If seller has received approval of HAMP loan modifications, HAFA guidelines (effective 4/5/10) prohibit reduction of commissions on short sales by participating banks. HAFA guidelines, however, do not apply to Fannie Mae and Freddie Mac loans, or to second loans.

Tax Consequences of Debt Forgiveness in Short Sales and Foreclosures
Debt Forgiveness Act of 2007 applies to all 50 states and basically provides for no tax on the short sale difference or foreclosure deficiency of purchase money loan if primary residence.

If the loan was used by the investor to purchase the home, the loan is non-recourse debt under Arizona law as the lender cannot sue the borrower after short sale or foreclosure; IRS Publication 4681 (p.11) updates 12/11/08 provides for no income tax on debt forgiveness of non-recourse debt.

In addition, if home is not primary residence but an investment, then there is usually a capital loss on the home after short sale or foreclosure, which could be available to offset any debt forgiveness income of the investor.

If non-purchase money loan, e.g., HELOC, any debt forgiveness will be taxable income (Form 1099 from lender). For example, if bank accepts $50,000 in payment of $75,000 HELOC debt, then Form 1099 to borrowers of $25,000.

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