This year the California Association of Realtors® (CAR) has sponsored state legislation (SB 458 – Corbett) that would negate the ability of a junior lien holder to collect any deficiency if they have agreed to a short sale. This is a follow-up to legislation (SB 931 – Ducheny) that passed and became law last year. SB 931, however, only applied to first trust deeds or mortgages according to an article in the International Business Times.
The problem that both bills have intended to rectify is this: When a lender releases a lien – a mortgage or trust deed – that is only a release of a security instrument. It is not a release of the debt obligation itself. Hence, in a short sale situation, a lender might say something like this: “I will agree to the short sale and as long as I receive X dollars, I will discharge the mortgage, thereby allowing a new lender to secure the buyer’s loan”. BUT, the original lender also says, “I reserve the right to pursue the deficiency (i.e. the difference between the amount owed and the amount received)”.
Sometimes the lender doesn’t even say that explicitly, they just do it. Commonly, only later does the seller find out that, legally, they still owe money. (Yet another good reason why a knowledgeable professional should review the lender’s short sale agreement.)
As noted, last year’s SB 931 fixed the problem with respect to first loans, but not for junior liens. The problem, thus, has persisted. 2nd (or 3rd or 4th or whatever) note holders will, for some consideration, agree to the short sale, but many times they will not release the debt obligation for the remaining amount. They may then pursue the collection of the debt themselves, or, frequently, they will sell the debt – heavily discounted – to a debt collection agency.
SB 458 – the proposed legislation – is intended to fix this by requiring that, if a junior lien holder agrees to a short sale, then the obligation is considered fully discharged and a collection of the deficiency is prohibited. Moreover, any waiver of this provision will be considered contrary to public policy. The borrower can’t even (enforceably) agree to be obligated for the remaining debt.