We all know of a friend, relative or neighbor who as a result of the economy or personal circumstances is not able to make the house payments or whose house is worth substantially less than the amount owed on the home loan.

Arizona and a small minority of other states have adopted laws that protect homeowners to a varying degree from personal liability after losing a home to foreclosure. Arizona’s anti-deficiency law found in Arizona Statute § 33-814(G) is best illustrated by an example:

1.Original purchase price of home    $200,000
2.Down payment: 10%    $20,000
3.Amount borrowed and current balance owned    $180,000
4.Current value of the house and the amount at which the house was sold at foreclosure    $150,000
5.Amount outstanding and due and owing to the bank on the money borrowed (“Deficiency”)    $30,000

The bank wants all of the money back it loaned to the homeowner and is $30,000 short when the property was sold at a foreclosure sale. This is termed a Deficiency.

Arizona law protects the homeowner from the bank’s claim for Deficiency if (1) the residence consists of a property on 2.5 acres or less, (2) the property is restricted to and used as a single-family or dual-family dwelling, and (3) the money borrowed from the bank was used to purchase the home.  Under these circumstances, the bank cannot pursue the homeowner for the $30,000 Deficiency even if the value of the house as sold at the foreclosure sale is less than the amount owed.

In common language, most individuals refer to the home loan as a mortgage. Arizona has adopted a deed of trust statute, and deeds of trust in Arizona generally have replaced the use of mortgages.

Deeds of trust are popular for lenders because the foreclosure (1) takes place without court action and (2) can be quickly accomplished, generally about 90 days after the Notice of the Trustee Sale.

In order to initiate a trustee sale, the bank must (1) record the Notice of Trustee’s Sale at least 91 days before the date of sale; (2) mail a copy of the notice to the homeowner within five (5) days after the Notice of Trustee’s Sale is recorded; (3) mail a copy of notice to all other parties having a recorded interest in the property; (4) post a copy of the notice on the property in a conspicuous place at least 20 days prior to the sale; and (5) publish the notice in a newspaper in a county where the property is located at least once a week for four consecutive weeks until at least ten days before the sale is held.

In certain instances, prior to recording the deed of trust, the lender must attempt to contact the homeowner to explore options that avoid foreclosure. This recent requirement, however, does not apply to loans purchased or serviced by federal, state or local housing agencies such as the Federal National Mortgage Association, Federal Home Loan Mortgage Corporation or mortgages that were collateralized as securities.3

The Arizona Supreme Court in the famous Baker vs. Gardner  caseheld that any lender holding a deed of trust on a residence may not waive the purchase money security and sue to collect a Deficiency (as in our $30,000 example). The objective in enacting A.R.S. § 33-814(G) was to “abolish the personal liability of those who give deeds of trust encumbering properties of 2.5 acres or less and used for single-family or two-family dwellings.” This anti-Deficiency protection is also applicable to investor-owned residential properties. So, too, the anti-Deficiency protection is available in the event the homeowner renews or refinances the residence.

Second Deeds of Trust and Home Equity Loans

Complications arise in connection with subordinate deeds of trust and home equity loans. The homeowner cannot be sued by the lien holder if the second loan was also a part of the purchase money transaction. If, however, the second loan is used to purchase a car or boat or for personal expenses, etc., the homeowner generally will be sued for the Deficiency. In the case of second mortgages and deeds of trust, homeowners should consult an attorney to ascertain their rights.

Other Liabilities of Homeowners

If a homeowner has damaged the property or physically abused or destroyed it, the homeowner can be sued by the lender for damages. Therefore, it is important to maintain insurance coverage until the trustee sale is completed.

Homeowner Association (“HOA”) fees generally are the personal liability of the homeowner, and initiation of a foreclosure proceeding on the property does not eliminate that obligation. The homeowner often will be sued for such delinquent fees. Therefore, HOA fees must be paid until the trustee sale is completed.

Homeowner Options

If the homeowner is exposed to a potential Deficiency, various options could and should be considered, including (1) a short sale of the property with consent and waiver of claims by all lien holders; (2) deed in lieu of foreclosure, i.e. giving the property back to the lender in consideration of the lender waiving all claims; (3) loan modification efforts with the lender; and (4) in extreme cases, filing personal bankruptcy.

Each and every one of the above initiatives has long-term consequences on the homeowner’s lifestyle: ability to purchase items on credit, self-esteem and quality of life will all be affected. Any homeowner faced with a bank claiming a Deficiency should see an attorney unless the fact pattern falls squarely within the anti-Deficiency protections under Arizona law. A full array of rights, duties, responsibilities and practical strategies should be explored.

Lat J. Celmins (lcelmins@mclawfirm.com) practices in the areas of Real Estate law, consultation on complex commercial litigation, and corporate, transportation and general commercial law.