Arizona's Anti-Deficiency Laws are Changing!

Arizona’s anti-deficiency laws are changing effective September 30, 2009!  Before agreeing to a foreclosure or short sale it is critical to understand your rights and obligations as a borrower.  In addition to damaging one’s credit, a foreclosure or short sale can result in a deficiency.  The change was intended to limit the type of borrowers that will qualify for anti-deficiency treatment.  Set forth below is a general outline of Arizona law regarding when a borrower may be subject to a deficiency action or sued on its note following a foreclosure or short sale.  However, borrowers must understand these are general rules — every situation must be analyzed carefully based on the specific facts – consult with a professional at all times to determine your rights and obligations in connection with a foreclosure or short sale. 

1.  In Arizona, if a borrower fails to pay its loan, a lender can foreclose its Deed of Trust lien either judicially per A.R.S. § 33-721 et. seq., or non-judicially by conducting a trustee’s sale per A.R.S. § 33-801 et. seq. 

2.  If the foreclosure does not pay a lender what it is owed, the lender may generally seek a deficiency against the borrower for balance of the loan.  However, certain states, including Arizona, have what are called anti-deficiency laws that bar a lender from seeking a deficiency in certain situations. 

3.  In determining if anti-deficiency rules apply, the first step is to confirm what law applies to the loan, particularly the lender’s remedies under the Promissory Note.  The applicable law should NOT be assumed.  Read your Promissory Note and other loan documents carefully and understand their terms.

4.  Assuming Arizona law applies to the lender’s rights under the Promissory Note, Arizona’s anti-deficiency laws are found in 2 places – in A.R.S. § 33-729(A) (regarding judicial foreclosures), and A.R.S. § 33-814(G) (regarding trustee’s sales).  

5.  Under existing statutes, in both judicial foreclosures and trustee’s sales, anti-deficiency rules apply only if the property being foreclosed meets the following criteria:  (a) 2½ acres or less; and (b) limited to and utilized as a single one-family or single two-family dwelling. 

However, on July 10, 2009 Gov. Brewer signed into law a change to A.R.S. § 33-814(G).  The change takes effect September 30, 2009.  In addition to the above requirements, the trustee’s sale statute will require that: (a) the trustor has utilized the property as a dwelling for at least 6 consecutive months; and (b) a certificate of occupancy has been issued for the property.  Under the existing trustee’s sale statute, there is NO requirement that the trustor use the property as a dwelling – just that the property be used by someone as a dwelling.  Thus, in most cases, residential investment properties currently qualify for anti-deficiency treatment if on 2 1/2 acres or less.  Under the new law, a property that has not been used by the trustor as a dwelling for at least 6 consecutive months will no longer qualify for anti-deficiency treatment.  This change raises many interesting issues and will add to the confusion surrounding deficiency issues (see back page).

Note:  Arizona courts have held that commercial properties and loans secured by residential homes being developed for sale but never used as dwellings do NOT qualify for anti-deficiency treatment under the statutes.  In addition, courts have ruled that a deed of trust that is a lien against more than one property will not be subject to anti-deficiency rules  – the deed of trust needs to be a lien against a single trust property. 

6.  For judicial foreclosures under A.R.S. § 33-729(A), there is the additional requirement that the loan be a purchase money (“PM”) loan for the borrower to get anti-deficiency treatment.  However, the trustee’s sale statute, A.R.S. § 33-814(G), does NOT require that the loan be a PM loan.  A PM loan does NOT lose its PM nature when it is refinanced.  However, cash out refi’s raise interesting issues.

7.  In judicial foreclosures, only a PM lender on qualifying residential property is prevented from seeking a deficiency; a non-purchase money (“NPM”) lender is not – it can obtain a deficiency following a foreclosure or sue the borrower on the note.  For several reasons, judicial foreclosures on residential property in Arizona are relatively rare — most lenders foreclosure via a trustee’s sale.

8.  In a trustee’s sale, both a PM and NPM lender that conducts the trustee’s sale on qualifying property will be prevented from seeking a deficiency after the foreclosure and from suing the borrower directly on the note. 

 9.  Junior liens extinguished by a 1st position foreclosure may be able to sue on the note.  The issue is whether the junior loan was a PM or NPM loan – if it was a PM loan on qualifying property, the lender can NOT sue the borrower on the note following the foreclosure; if it was a NPM loan, the lender CAN sue the borrower.

10.  If a lender can not seek a deficiency, then the lender can NOT waive its security and sue directly on its note.  This means that a lender under a PM loan on qualifying property will NOT be able to sue the borrower on the note.  This rule also applies to short sales.  Note there are gray areas regarding cash out refi’s.  Other Lender claims are also not barred – e.g. mortgage fraud.

11.  Even if anti-deficiency rules apply, a borrower will be liable to a lender for any diminution in value of the trust property due to voluntary waste.  In other words, don’t damage the property, take fixtures, A/C units, etc., or let the Property go to waste.

12.  Real property taxes are NOT an owner’s personal obligation, but only a lien against the real property.  However, HOA assessments ARE an owner’s personal obligation and if not paid can result in credit damage, lawsuits and other collection efforts.

13.  Last, but not least, consult with qualified tax professionals BEFORE deciding to do a short sale or foreclosure.  1099 income, gains, losses and other tax consequences may result from foreclosures, short sales and loan modifications.  Know what tax consequences you will face and plan accordingly!

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