Refinanced Mortgages: Recourse or Non-recourse
Recourse vs. Non-recourse Loans: Refinances
By Edward Pamintuan, Esq.
After a bank forecloses on a property and sells the property to make up for the money it loaned out to a consumer often times the sale price of the property does not cover the entire amount of the mortgage or mortgages that were taken out on the property. This amount that is not covered is call a deficiency. Sometimes lenders may sue a consumer to recover this deficiency. However, some lenders may be barred from doing so if the loan is a non-recourse loan under California Law; in other words, other than the foreclosure the bank has no other recourse to get back the money it loaned to the consumer. Non-recourse loans are addressed in California Code of Civil Procedure Section 580b, also known as the “anti-deficiency statute".
This article covers the “uncharted territory" of how the anti-deficiency statute applies to loans that are a refinance of a purchase money mortgage. The legal community has had trouble with this issue and many attorneys have reached the conclusion that a deficiency on a refinance of a purchase money mortgage is an amount a lender can sue for after a foreclosure has been completed. This is unfortunate because an overwhelming amount of consumers, about 2/3 of consumers, refinance their mortgages and because a detailed reading of the law and the intent of the California Legislature shows that these types of loan are non-recourse loans for which lenders cannot sue to obtain judgment.
To explain my findings it is important to discuss 580b, the anti-deficiency statute, specifically the newly passed 580b(c). In addition, it is important to point out that this analysis only covers a situation where a homeowner refinances an original purchase money mortgage and does not use the cash out of the refinance to buy items or things unrelated to improving the home or refinancing the home.
California Code of Civil Procedure 580b(c)
580b(c) amends and adds to 580b “the anti-deficiency statute" a provision preventing lenders from obtaining a deficiency judgment on a loan, mortgage or deed of trust that refinance or modify the original purchase money loan. More specifically, it states that [F]or the purposes of [508b], a loan used to pay all or part of the purchase price of real property shall include subsequent loans, mortgages or deeds of trust that refinance or modify the original loan…the provisions of this subdivision shall only apply to credit transactions that are executed on or after January 1, 2013.
Obviously, the problem here is that the subdivision, the statutory law, only applies to transaction that are executed on or after January 1, 2013 but read on…
Case Law Supporting the Idea that a Refinance is a Recourse Loan
It is generally accepted by the bar, incorrectly, that a note that is a refinance of a purchase money loan is a recourse loan. The case that creditors normally cite to argue that a homeowner who refinances his or her original loan loses Section 508b protection against deficiency judgments is Union v. Wendland (1976) 54 Cal. App. 3d 393. That case notes: Section 580b was drafted to protect purchasers under the standard purchase money mortgage transactions in which the vendor of real property retains an interest in the land sold to secure payment of part of the purchase price…"variations on the standard are subject only if they come within the purpose of that section."…The loan transactions with [the refinancing lender] are variations from the standard that do not come within the purpose of 580b. Accordingly, when the homeowner refinanced the property…he lost the purchase money protection afforded by section 580b.
However, I am of the opinion that 580b(c) clarifies the holding in Wendland to the benefit of borrowers and that Wendland is bad law, at least when applied to the standard refinancing situation.
Arguments that 580b(c)/Anti-deficiency protection Applies To Refinanced Purchase Money Mortgages
It would seem that because the newly passed 580b(c) indicates that the bill only affects refinances executed on or after January 1, 2013 that the bill does not have any affect on refinanced mortgages that occurred before January 1, 2013. However, the legislative history of the California Legislature indicates that the legislature knew that the bar had relied on Wendland in accepting that a refinance is a recourse loan and the history also indicates that 580b seeks to respond to Wendland by clarifying that no deficiency judgment shall lie on any loan, refinance, or other credit transaction which is used to refinance a “purchase money loan". In other words, although the bill only affects credit transactions executed after January 1, 2013 it has clarified the holding in Wendland though it does not abrogate it.
From my research, it is obvious that this case and this area of law needed much clarification. The fact that the bar has relied on Wendland in accepting that refinance mortgages are recourse is ridiculous.
The facts in Wendland are not analogous to many standard mortgage/deed of trust transactions. In Wendland the borrower did not execute any purchase money loans; the borrower purchased property in 1966, executed a note and deed of trust securing the property with a savings and loan in 1967 (not as purchase money), then executed a second note with the same savings and loan (not secured by a deed of trust) for the purpose of remodeling the property (again, not purchase money), and then in 1969 executed a third note and second deed of trust to refinance the second note and to use the left over balance to make payments on the first note. The California legislature recognized the problems with applying Wendland to the typical refinance situation and by enacting 508b(c) sought to clarify this area of law.
The legislative history indicates that the clause indicating that 508b(c) only affects refinances that are executed after January 1, 2013 was a concession made to pass the law and legal necessity because in 2010 a similar law (not containing a prospective clause) that presented was to Governor Schwarzenegger was vetoed by him because he felts that the law “fundamentally alters the nature and impairs the value of previously negotiated contracts…" He vetoed the law because he felt it modified preexisting contracts.
Courts of Appeal in California have used a two-part test to determine if the protection offered by 580b(c) applies in certain foreclosure situations: 1) does the sale vary from a standard purchase money transaction, and if it does, 2) does applying section 508b’s antideficiency protection comport with the Legislature’s intent? Anti-deficiency applies unless the answer to the first question is “yes" and the answer to the second question is “no". Spangler v. Memel (1972) 7 Cal. 3d 603.
One could make the argument that the typical refinance situation does not vary from standard purchase money transactions. About 2/3 of mortgage originations are derived from refinances. A refinance of of original purchase money loans and subsequent foreclosure of the property upon which the refinance note was secured is common. Refinances of purchase money mortgages were and are the norm.
The legislature’s intent in originally enacting 580b was to create a stabilizing measure. 1) It stabilizes purchase money secured land sales by keeping the vendor (lender) from overvaluing the property and by suggesting to the purchaser its true value and 2) if property values drop and the land is foreclosed upon, the purchaser’s loss is limited to the land that he or she used as security in the transaction, purchasers as a class are harmed less than they might otherwise be during a time of economic decline, and the economy benefits. It’s clear that applying the antideficiency protection to refinances of purchase money notes comports with legislative intent because it is the banks and lenders not the consumer who stand to benefit from overvaluing property and it is the banks and lenders not the consumer who is the party in the dominant position when it comes to all loan transactions
The case law and legislative history strongly indicate that a refinance is a non-recourse loan for which lenders cannot obtain a deficiency judgment to recover. As of this time, the Court of Appeal have given no definitive answer to this issue but strong legal arguments exist that benefit the consumer.