As regular readers to my Blog should know, under California law (Civil Code Section 580b), if a lender makes a loan to enable a borrower to buy a 1-4 unit property which they live in, the lender has no recourse against the borrower. They can only take (foreclose) the property. They cannot get a judgment against the borrower if the property is not worth the amount owed on the loan. This is called an “acquisition loan”.  If the borrower later refinances this loan by getting a new loan, this protection is generally lost because the new loan was not obtained to acquire the property.  That makes sense.  But what about a loan modification?

Recently, several clients have had lenders (or collection companies) tell them that their loans became recourse because they got a loan modification.  From what I can see, this appears to be false and is no doubt said in an attempt to collect some money even when there is no recourse.

The First reason that this is false is that the loan and security (deed of trust) have not changed. It is still the acquisition loan and the same date of purchase recorded security.  Second, there is a rule in law called “substitution”.  The substitution doctrine applies when an acquisition loan is refinanced by the lender holding the original acquisition debt. The acquisition portion refinanced retains its purchase money character and the anti-deficiency protections of CCP §580(b) apply. (Union Bank v. Wendland, 1976).  Further there is legal authority that the protection extends to situations where the “beneficiary of the purchase-money loan ‘refinances’ the loan, ie: same lender, borrower, and security, but different loan amount.  From these sources, it appears fairly clear that a modification will not alone convert a non-recourse acquisition loan into a recourse loan.  As the court said in the Union Bank case, “…. the protections of the anti-deficiency statutes can not be avoided because of some clever paper shuffling on the part of the lender. To allow such is a circumvention of the anti-deficiency statutes.”

 We recently had a case in which our client had bought a home using 1st and 2nd acquisition loans. When she later sought a $6,000 education loan from the same lender, the lender replaced her 2nd loan with a Home Equity Line of Credit (HELOC) which included the original 2nd loan amount of $76,000 plus the additional $6,000. When the market later crashed and our client was losing her home, the lender claimed that the new 2nd loan was a refinance and thus they had recourse. They then sued the borrower for the entire $82,000.  Clearly the Substitution Doctrine should apply here at least to the $76,000. Unfortunately,  other financial issues have forced our client into Bankruptcy so this will not get resolved, but based upon the Union Bank holding and other cases, we are confident that our client would prevail on her claim that the $76,000 is non-recourse.

Of course, none of the above is going to stop unethical lenders and collection agencies from threatening and scaring borrowers into paying money on non-recourse debt.

If you have specific questions about your liability, foreclosure, or any legal issue, feel free to contact me at sjbeede@bpelaw.com or call us at (916) 966-2260 for a phone or personal appointment.  Need help Coping with an Upside Down Loan? Checkout Steve’s audio-seminar and e-book at: http://www.stevebeede.com/copingwithanupsidedownmortgage/.