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Relief To Homeowners From Potential Deficiency Claims

RELIEF TO HOMEOWNERS FROM POTENTIAL DEFICIENCY CLAIMS
(AND SOME PITFALLS!)

Question: I’m a homeowner facing foreclosure, and understand the law has changed regarding my lender’s rights to go after me for a deficiency claim. First, what the heck is a deficiency claim, and second, how has the law changed, and does it benefit me?

Answer: The short answer is yes, Oregon law relating to a lender’s right to bring a deficiency claim changed effective July 11, 2012.

The long answer starts with an explanation of what a deficiency claim is and how the law worked prior to July 11, 2012, how the new law changed the playing field, and then addresses a few unintended consequences of the new law which can create a trap for the unwary.

What is a deficiency claim (or deficiency rights of a lender)? In its simplest form, a deficiency claim is a claim by the lender against the borrower for the deficiency. A deficiency is the difference between what the lender recovers at a foreclosure sale, and what the lender is owed on the loan. As an example, if the lender at the time of the foreclosure sale is owed $200,000, but the property only sells for $150,000 at the foreclosure sale, the deficiency is $50,000. This is the amount the lender is “short” on getting paid back what it is owed.

Under prior and existing Oregon law a lender has two ways to foreclose a trust deed – one is known as a nonjudicial foreclosure (also known as a foreclosure by advertisement and sale), which does not involve the courts, and the other is known as a judicial foreclosure, in which the lender actually files a lawsuit against the borrower and seeks to obtain a judgment of foreclosure, followed by a sheriff’s sale of the property. Under prior and existing law, if the lender elected the remedy of a nonjudicial foreclosure, and completed the sale, the lender could not preserve a deficiency claim against the borrower – essentially the lender was stuck with what it could get out of the property.

Under prior and existing law, however, if the lender elected the remedy of a judicial foreclosure, if the trust deed being foreclosed was not a “residential trust deed”, then the lender would have the right to obtain a judgment for the deficiency against the borrower – under the example above, a judgment for $50,000, and try to collect this deficiency judgment from other assets of the borrower.

So, the key is whether the trust deed is a “residential trust deed”, and this is where the new law comes into play. Previously, a “residential trust deed” was defined as a trust deed against a property which was occupied by the grantor (usually this is the borrower, and I will use the term borrower to mean grantor), or the borrower’s spouse or minor children, as the primary residence, at the time of the commencement of a foreclosure action. In other words, whether a trust deed was a “residential trust deed” was dependent upon whether it was occupied as the primary residence when a foreclosure process started – whether judicial or nonjudicial. It if was not, it was not a residential trust deed, and if the lender elected to foreclose judicially, it could obtain a deficiency judgment.

Under the new law (enacted through Senate Bill 1552), whether a trust deed is a ” residential trust deed” is not based upon whether the property was occupied as the primary residence at the time of the start of the foreclosure process, but whether the property was occupied as the primary residence at the time of the default under the loan leading to the foreclosure sale (my language – the exact wording of the statute is that a “residential trust deed” is one which is against a property which the borrower (or identified spouse and dependents): “…occupies as a principal residence at the time a default that results in an action to foreclose the obligation secured by the trust deed first occurs.”)

Let me give you a clear example of how the change works. Assume that a borrower stops making the monthly payments on a loan beginning August 1st (and the borrower is then occupying the property as the primary residence), and makes no further payments on the loan, and the lender starts a foreclosure action which is based upon the borrower defaulting under the loan as of August 1st. While there are some nuances which are beyond the scope of this column, under the new law, because of the borrower’s occupancy as of August 1st, the lender would not be able to seek a judgment for the deficiency.

What is the practical effect of this change?

Once the borrower defaults under the loan, as long as the borrower (or the other identified parties), occupied the property as the primary residence as of that date of default, the borrower could move out of the property and still know that they had the certainty of not facing potential liability for a deficiency claim. This could be important, for example, if the borrower needed to move because of a change of job.

Under prior law, the borrower was essentially tethered to the property until the foreclosure sale was completed, because the lender always had the right to change the remedy (unfortunately, this was one of little known elements of the foreclosure process generally not explained to a borrower who did not have access to legal counsel). An example of this: if a lender started a nonjudicial foreclosure on May 1, with a sale date set for September 1, the borrower occupied the property as the primary residence on May 1, and the borrower later moved out of the property, for whatever reason, the lender, up until September 1, could change its mind and stop the nonjudicial foreclosure and start a judicial foreclosure. So, if this happened, and the lender filed the judicial foreclosure complaint on August 15th, and the borrower was no longer occupying the property as the primary residence, the lender could now obtain a deficiency judgment. The new law stops this from happening, by fixing the determination date based upon the date of default and not the date of the start of the foreclosure process.

Under the new law, once the default occurs, the borrower can move out of the property (whether because of a need to do so (because of a job change, for example), or because of a desire to do so (indeed, the borrower could move out of the property and convert it to a rental, and still not face a deficiency claim).

What is the “TRAP” associated with this change?

An example is the best way to illustrate the potential trap to a borrower. Assume that a borrower has been renting a property, defaults under the loan, and then, before a foreclosure action starts, moves back into the property and occupies it as the primary residence. Under the old law, because the property was occupied as the primary residence at the time the foreclosure action started, the lender had no right to seek a deficiency judgment.

Under the new law, this is not the case. Under the example above, even if the borrower occupied the property as the primary residence at the time the foreclosure action started, because the borrower did not occupy the property that way at the time of the default under the loan, the lender could still seek a deficiency judgment through a judicial foreclosure (remember, if the lender elects to and goes all the way through the process of a nonjudicial foreclosure, the lender will not have a deficiency claim, without regard to the nature of the occupancy of the property). It would appear the only way for a borrower to avoid this from happening would be to bring the loan current, and then, after taking occupancy of the property as the primary residence, defaulting again under the loan. This could prove to be quite a burden to a borrower, but at the time, would appear to be the only way to avoid facing the possibility of a deficiency claims for tens or hundreds of thousands of dollars.

As a final side note, in the past, this change may not have had much of an impact because almost all residential lenders would elect the remedy of nonjudicial foreclosure, which precludes deficiency claims. However, because of the MERS fiasco, and recent federal and Oregon appellate court rulings, many residential lenders are opting to proceed with judicial foreclosures, because they otherwise may not be able to obtain marketable title following a nonjudicial foreclosure.

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