The Oil Drum

Rick,

A very good question. Though not exactly our forté.

I put it to Tanta at Calculated Risk, who has an amazing depth of knowledge in these matters, and she was gracious enough to reply within the hour. I'll quote her entire response here, and thank her very kindly.

In a purchase money security interest, where you get an initial mortgage to buy a house, the loan is normally non-recourse

I see that claim made a lot. It is true that, for instance, in California purchase money loans are non-recourse. That is not universally true; such laws are made at the state level. There is a certain Californiacentric view of the world.

Where recourse limitations on purchase money exist, they tend to make lenders more cautious about purchase money loans, since it is true that you cannot get a deficiency judgment (the technical term here) when foreclosure proceeds are less than the loan amount. That cautiousness went away in the boom in some quarters. Now lenders are remembering why such laws are on the books. That's the point, by the way: the law doesn't say you can't lend 100% of value. The law lets lenders be stupid. It just doesn't let lenders make upside down loans with the idea that the upside down part is "secured" by the borrower's other assets. The law basically says that the house is the only security you have on a purchase money loan, so you should make sure that the appraised value is good and the borrower is creditworthy.

I know of no jurisdiction in which there are recourse limitations on refinances, except for Texas cash-outs, and trust me, we don't want to talk about Texas cash-outs. But the important point is that no one in any jurisdiction can get a deficiency judgment without doing a judicial foreclosure. (You must plead before a judge to get a judgment.)

So "trustee sales" or non-judicial FCs don't result in deficiency judgments because they can't. They are, however, much cheaper and faster than judicial FC. So a lender has to really have a big dollar amount at stake to go judicial when the state allows nonjudicial (like CA). Some states do require all judicial FCs, like Ohio. Those are the states in which deficiency judgments are most likely to occur, because you're always in court anyway.

Bottom line: if lenders preferentially sought judicial FCs just so they could get a judgment against the borrower, it would certainly slow down the "clearing" of the REO market, given how it would extend the FC timeframe. However.

I have no reason to believe lenders will do that. It costs them more than the judgment is worth. The usual practice is that lenders seek a deficiency judgment only when they believe that the loan was fraudulent. That is, when there is some evidence that cash assets are there, but the borrower won't use them to make mortgage payments with.

Not "fraudulent" in the sense of "the borrower lied." A whole lot of borrowers lied, but the problem is they don't have the money they said they had and it is a giant waste of time and money to get judgements they'll never pay. You pursue deficiency against those who claim they don't have the money that you think they do have, like those operators who put their assets in sham "trusts" prior to default and then tell the lender they're broke.

That help?

Cheers, Tanta