Can a lender collect after a short sale? What can they do with the deficiency?

May - 03 | | No comments. | Blog

A short sale is an agreement and a settlement, meaning; whatever terms are in the approval letter are the terms of the new agreement. Most sellers are oblivious to the fact that lender almost ALWAYS try to leave in verbiage that allows them to collect from you AFTER the short sale.

Ok, so we know that when it is a purchase money loan (first or second) on a primary residence in California, that the bank cannot obtain a deficiency judgment, even if they decide to do a ‘judicial foreclosure’.  Also, if the foreclosing lender on any residential property (second home, investment) or loan type (cash out or rate/term refi) elects to use a Trustee Sale instead of a Judicial Foreclosure, that foreclosing lien position CANNOT seek a deficiency judgment.  Period.

If the second lien is NOT the same lender as the first lien and they did not foreclose (which is most common, the first is typically the foreclosing lender) that second lien DOES have recourse capabilities.  In most foreclosures, what usually happens is that when both the first and the second liens are in negative equity positions, the second will follow the path of NOT seeking to foreclose, allowing its security interest in the property to be wiped out through the foreclosure by the first lien.

As a result the second lien will proceed as though they are an unsecured lender, seeking to collect via a lawsuit.  This isn’t a ‘deficiency judgment’, but simply a suit on an unsecured promissory note.

It’s rare, but in cases where the second lien IS the foreclosing lien and the first is being paid in full, if the second forecloses via Trustee Sale (again, this is for those of us in CA), they have NO RECOURSE, unless they were to proceed with a Judicial Foreclosure in which case they would obtain the deficiency judgment through the judicial foreclosure sale.  It doesn’t matter that it was a cash out refi, second home, investment property, etc, if the foreclosing lender elects to proceed with a non-judicial foreclosure, they cannot obtain a judgment per CA law.

BUT, what about your cases where both liens are with the SAME LENDER and both liens are negative in their equity positions and the first lien is foreclosing???  Well, in 1992 we had a case in CA that set the precedent for future foreclosure case law regarding the ‘one action’ rule.  If the first and the second are both with the same lender, when the first forecloses (via a Trustee Sale), the second CANNOT sue the seller for the balance.  Remember, this is ONLY in CA where both liens are with the same lender i.e. Chase/Chase or BofA/BofA, etc.

(Simon v. Superior Court)

So, what does this all mean to the homeowner?  When you are fighting to remove the ‘we reserve the right to seek a deficiency judgment’ verbiage on your short sale approval letters, use your knowledge of the CA state law as ammo to leverage the deal.

Of course thats easier said than done, but fortunately we have put together a potent letter that does a good job of this. When used correctly it can yield powerful results. 

If you are considering a short sale be sure you understand the snares lenders will lay for you.


(I recently sold my short sale negotiation company where I personally negotiated over 1,500 short sales. Now I help California homeowners buy and sell real estate in my hometown of San Diego California.)

Sean Chapman

Chapman Real Estate Group



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