Arizona Anti-Deficiency Law

There are two methods a lender may use to foreclose no a property in Arizona.  The borrower's rights and protections under the Anti-deficiency law will depend on which of the two methods the lender, in the lender's sole discretion, chooses to utilize for the foreclosure.  Please note that the anti-deficiency law only applies if a trustee sale or judicial foreclosure actually occurs.  The law does not apply to a short sale or a deed in lieu of foreclosure transaction. 

TRUSTEE SALE PROCESS

JUDICIAL FORECLOSURE PROCESS
AN ACTUAL LAWSUIT

1.  Deed of Trust only

1.  Any encumbrance on real property, including a Deed of Trust.

1.   Does the mortgage or deed of trust secure property that is located on two and one-half acres or less?

2.  Is the property a single one-family or a single two-family dwelling actually used as a residence by someone (including rental property)?

1.   Does the mortgage or deed of trust secure property that is located on two and one-half acres or less?

2.  Is the property a single one-family or a single two-family dwelling actually used as a residence by someone (including rental property)? 

3.  Is the loan secured by the mortgage

or deed of trust a "purchase money" loan?

If the answer to each the above is yes, then the lender can not sue the borrower for any additional funds.

If the answer to each the above is yes, then the lender can not sue the borrower for any additional funds.

 

COMMON QUESTIONS 

I have my original loan from when I bought my home and it forecloses: 

Regardless of how the lender pursues a foreclosure, the lender can not come after the borrower for any unpaid balance on the loan (a “deficiency”).   

I have my original loan on an investment property and it forecloses: 

Regardless of how the lender pursues a foreclosure, the lender can not come after the borrower for any unpaid balance on the loan (a “deficiency”).  The anti-deficiency law applies to all properties that meet the physical requirements.  There is no requirement that the property be owner occupied.  Investment properties are covered by the law. 

I have my original 80/20 loan on the property and the first position lender forecloses: 

Regardless of how the first lender pursues a foreclosure, the lender can not come after the borrower for a deficiency. 

What happened to the junior (20%) loan after the foreclosure: 

The junior was wiped out by the foreclosure of the first position lender.  But because the second

position lender (20% loan) was purchase money, then just like the first, it can not obtain a deficiency against he borrower.  

I refinanced by original purchase loan but did not pull out any cash: 

The lender probably can not come after the borrower for a deficiency but there is some minor risk in this situation.  If the lender forecloses with a trustee's sale, then the lender can not come after the borrower for a deficiency.  The only risk exists if the lender pursues a judicial foreclosure as the refinance may not be considered a “purchase money mortgage.” 

I refinanced my home and pulled money out to invest in other properties: 

The loan has probably lost its protected status as a “purchase money mortgage”.  However, if the lender forecloses with a trustee's sale, then the lender can not come after the borrower for a deficiency.  The only risk of a deficiency judgment exists if the lender pursues a judicial foreclosure, in which case the lender can get a deficiency judgment against the borrower. 

I left my original loan in place but I took out a home equity line of credit against my property, and now the first position lender is foreclosing: 

Regardless of how the lender pursues a foreclosure, the first position lender can not come after the borrower for a deficiency.  The risk to the borrower is the HELOC. 

I left my original loan in place but I took out a home equity line of credit against my property, and now the second position lender is foreclosing: 

The second position HELOC loan is not a protected “purchase money mortgage”.  Accordingly, if the lender pursues a judicial foreclosure, then the lender can get a judgment for the unpaid loan amount against the borrower.  But, if the lender pursues a trustee's sale, the lender can not come after the borrower for anything else. 

I left my original loan in place but I took out a home equity line of credit against my property, the first position lender foreclosed, and now he second position lender is threatening to sue for the balance of the wiped out loan: 

This is the position of greatest danger to a borrower with a junior position non purchase money mortgage such as a HELOC.  The wiped out lender can sue the homeowner for the entire balance of the wiped our junior position loan. 

Do I get a 1099: 

Federal law generally requires that any debt that is forgiven or cancelled by a lender must be included as income on the borrower's tax return and is taxable. The amount of the forgiven debt is identified on a 1099.  Federal law requires that a 1099 must be issued by a lender anytime there is debt that is forgiven.  Accordingly, the proper question is not whether a 1099 will be given, as one will almost always be given, but whether the income identified on the 1099 is taxable to the borrower.   

Do I have taxable income if: 

If they live in the house 2 of the last 5 years do they qualify for the debt relief act? 

Yes, assuming you satisfy the other requirements.  The debt relief act applies to forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes, may be excluded as income.  The two year time period is part of the test for a primary residence. 

DO I get a deficiency if: 

Primary residence with a 1st & 2nd the 1st forecloses the property is sold at auction.

Investment property with 1st & 2nd the 1st forecloses the property is sold at auction. 

The issue of primary residence v. investment property is not relevant to the deficiency issue, but is relevant to the taxation issue. 

And property that satisfies the anti-deficiency law will result in a lender being unable to pursue a deficiency.  This is true regardless of whether the property is a primary residence or an investment property.  Thus, an investor could own multiple properties, all of which are in foreclosure, and have the protections of the anti-deficiency law on each property. 

However, the distinction between primary residence v. investment property is relevant to the taxation issue.  Only forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes, may be excluded as income.   

Primary residence with a 1st & 2nd   the 2nd forecloses the property is sold at auction.

Investment property with 1st & 2nd the 2nd forecloses the property is sold at auction. 

The loan has probably lost its protected status as a “purchase money mortgage”.  However, if the lender forecloses with a trustee's sale, then the lender can not come after the borrower for a deficiency.  The only risk of a deficiency judgment exists if the lender pursues a judicial foreclosure, in which case the lender can get a deficiency judgment against the borrower. 

Primary residence with a 1st & 2nd   the 1st forecloses the property is sold through a short sale

Investment property with 1st & 2nd the 1st forecloses the property is sold through a short sale 

The anti-deficiency law does not apply in a short sale transaction or a deed in lieu transaction.  Accordingly, unless the short sale or deed in lieu documentation provides that the debt is forgiven, then the lender may sue the borrower for the balance. 

Income derived from forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes, may be excluded as income, will not be taxable as income.  Accordingly, a short sale on a primary residence will protect the borrower from the tax liability. 

Primary residence with a 1st & 2nd   the 2nd forecloses the property is sold through a short sale

Investment property with 1st & 2nd the 2nd forecloses the property is sold through a short sale 

The anti-deficiency law does not apply in a short sale transaction or a deed in lieu transaction.  Accordingly, unless the short sale or deed in lieu documentation provides that the debt is forgiven, then the lender may sue the borrower for the balance. 

Income derived from forgiven or cancelled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes, may be excluded as income, will not be taxable as income.  Accordingly, a short sale on a primary residence will protect the borrower from the tax liability. 

Does the deficiency depend on if the loan was used for purchase/improvements vs. cash out?

The anti-deficiency law has very specific conditions for when it applies.  Those conditions differ based upon the method of execution pursued by the lender.  If the lender forecloses with a trustee's sale, then the lender can not come after the borrower for a deficiency for the specific conditions are satisfied.  However, those conditions do not make a distinction between owner occupied, home improvements or cash out.  The only risk of a deficiency judgment exists if the lender pursues a judicial foreclosure, in which case the lender can get a deficiency judgment against the borrower if the debt is not purchase money.  Home improvements and cash out are not protected.  

What verbiage has to be in a short sale approval letter for the lender to waive their right to a deficiency? 

The lender accepts the short sale proceeds as payment in full of the outstanding obligation.