If you have been following my Real Estate Law Blog posts you may have already read about some of the recent legal developments related to foreclosures and short sales in Arizona. However, in light of a new Court of Appeals case just decided last month, I felt it was time for a summary of these recent developments.
Construction Loans and Home Improvement Loans:
A ruling last month by the Arizona Court of Appeals in the case of Helvetica Servicing Inc. v. Pasquan answers important questions in the law and may impact anti-deficiency protections for some people. This case involved the refinance of an original purchase money loan, in which the borrower was loaned additional funds. The additional funds were primarily used by the borrower: (1) to reconstruct a large portion of the home, and (2) for home improvements and related purposes.
The Court of Appeals ruled on several key issues that have been in dispute in Arizona. The Court laid out the following rules to follow when determining whether a refinanced loan or construction loan will be given purchase money status under Arizona law in certain situations and thus, afforded anti-deficiency protection in the judicial foreclosure context:
A refinance of a purchase money loan, whether by the original lender or a new lender, does NOT destroy purchase money protection to the extent the loan proceeds from the refinance are used to satisfy the underlying purchase money loan.
A construction loan given to borrower that is (1) secured by a deed of trust that covers both the land and the dwelling to be constructed on the land (provided the dwelling is a qualifying property under the anti-deficiency statute), and (2) actually used to construct the dwelling, will be afforded purchase money status and anti-deficiency protection under Arizona law.
- Loan proceeds given to a borrower in a refinance that are clearly not used to satisfy an underlying purchase money loan may be traced, segregated and recovered in a deficiency action. In other words, the lender can sue on the cash out portion of the loan.
The Court’s ruling in this particular case was in a judicial foreclosure deficiency context, but it provides guidance to borrowers and authority to lenders dealing with deficiency actions or actions on the junior note by junior lenders before or after a foreclosure sale by the senior lender. In other words, in cash out refinances or combined purchase money/HELOC loans in which the junior lender can trace the underlying purchase money and cash out components of the loan, the junior lender can sue on the cash out portion, but only on the cash out portion, of the loan.
As far as the Court’s treatment of home improvement loans, pool loans, and the like, the Court suggested that those loans would not get purchase money protection. The Court noted that the lender’s right to sue on these types of loans will be determined on a case by case basis.
At this point, we must wait to see whether the Court of Appeals’ decision is appealed to Arizona’s Supreme Court, but this ruling does clear up some of the uncertainty and confusion regarding lender rights to pursue a borrower for a deficiency on a non-purchase money loan.
Note that the Court’s decision does not affect a lender’s or borrower’s rights in a trustee’s sale foreclosure — a lender that forecloses its deed of trust at a trustee’s sale will be barred from seeking a deficiency against the borrower as long as the property is a qualifying dwelling under the statute — the loan does NOT have to be a purchase money loan.
Occupancy Requirement Under Arizona’s Anti-Deficiency Law:
The rule in Arizona has been that if the property had not been occupied and used as a dwelling, the borrower would not get anti-deficiency protection. As a result, lenders could pursue borrowers for a deficiency after a trustee’s sale or judicial foreclosure on homes under construction that had not been completed or occupied. However, late last year, the Arizona Court of Appeals in M&I Marshall & Ilsley Bank v. Mueller expanded protections to borrowers who intended to occupy their new home, but were unable to do so.
In this case, a borrower took a construction loan to build a residence that, if it had been completed and actually utilized as a dwelling, would have received anti-deficiency protections after a trustee’s sale. The borrower was unable to complete construction, however, and no one ever actually moved into the home. The Court distinguished a prior holding of the Arizona Supreme Court and held that here, the borrower was a homeowner (as opposed to a commercial builder of residential properties as in the prior case), and the borrower had intended to occupy the dwelling upon completion of construction. This holding expands anti-deficiency protection to certain constructions loans and will be applied on a case by case basis.
While short sale results have been improving, the law has not been clear regarding short sales and, therefore, which has led to a veritable minefield for the homeowner/borrower. However, a bill recently introduced in the Arizona House of Representatives, House Bill 2584, would bar lenders from seeking a deficiency against certain borrowers following completion of a short sale. The bill is intended to cover loans that would get anti-deficiency protection if the property were to go into foreclosure. While some questions as to how the law will be applied need to be addressed, this law is a big step in the right direction.