Is a troubled mortgage reason enough to file bankruptcy?

Let’s assume for the sake of discussion that your financial house (no pun intended) is in order except for an underwater home. You owe far more than the home is worth and can’t afford to maintain the mortgage any longer. Your fear is that your lender will sue you for a deficiency judgment after foreclosure. Is it time to file for bankruptcy?

Maybe not. In some states, legislation prevents lenders from suing borrowers for deficiency judgments after foreclosure. For example, Arizona has an anti-deficiency statute that protects foreclosed borrowers from personal liability. Tucson bankruptcy attorney, Stephen Trezza, explains the implications of the Arizona statute in his post: I lost my home in foreclosure, am I responsible for any deficiency on my loan?

Arizona has an anti-deficiency law that is spelled out in ARS§33-814. In order for the statute to protect you from a deficiency after foreclosure the following circumstances must exist:

1.   The home is situated on 2.5 acres or less;

2.   The home was used as a dwelling;

3.   A trustee sale occurred

So long as these three elements exist than you are not responsible for any difference between the value of the home and the amount of debt outstanding on the home.

Similarly, California has enacted fairly strong anti-deficiency legislation that applies to purchase money mortgages secured by owner occupied residences. The California purchase money mortgage requirement is met if the proceeds of the mortgage went entirely towards the purchase of the home. As long as you borrowed money solely to buy your home, you’re fine. However, refinance arrangements where the borrower has taken cash out of the home do not qualify as purchase money.

California’s second criteria of an owner occupied residences is meant to limit the protection of the anti-deficiency statute to primary residences and to exclude investment properties. If you’re living in the property and there are four or less units, you are protected from a deficiency lawsuit.

The final hurdle required to bring California’s anti-deficiency statute into play is that the foreclosure must be non-judicial. Since the vast majority of home foreclosures in California are non-judicial, this is usually an easy element to satisfy.

The Bottom Line

The point of briefly walking through Arizona and California anti-deficiency law is to point out that bankruptcy might not be necessary for borrowers whose only financial problem is a home. It is important to meet with an attorney to discuss your state’s law to determine whether your lender has the option of suing after foreclosure. Even in states without anti-deficiency laws, in some cases lenders will elect to simply write off the debt rather than pursuing an insolvent borrower.

Meet with an attorney to learn more.