If a homeowner fails to make a certain number of payments on their home loan ("mortgage"), the lender may try to work out an agreement with the homeowner (e.g. they may accept interest only payments or partial payments for a short period of time, restructure the loan for a greater number of years but at a lower interest rate, or agree to a short sale) to avoid foreclosure. When a homeowner has fallen behind on their mortgage payments and an agreement is not feasible, the lender may proceed with foreclosure. Foreclosure allows the lender ("mortgagee") to declare the entire mortgage debt due and payable immediately. If the property is foreclosed on, the lender will acquire title to the property which will then be sold to pay the mortgage. Any shortage between the sale price and the outstanding balance of the mortgage is called a deficiency.

The question here is whether the borrower or homeowner is responsible for that deficiency. In some states, the homeowner is responsible for the deficiency. In other states, like California, the law prevents a mortgage lender from seeking to obtain a deficiency judgment following a foreclosure sale when the loan(s) foreclosed on was used to acquire a residential property of one to four units in which the purchased lived. Thus, in California if the property foreclosed on only has a purchase money mortgage which was used to acquire a home lived in by the purchaser, the purchaser will not be held responsible for any deficiency and can just walk away and owe nothing.

However, California's anti-deficiency laws, embodied in the Code of Civil Procedure Sections 580(b) and (d), do not afford a homeowner any protection if the outstanding balance on a loan foreclosed on was either a refinance, second mortgage, home equity line of credit, OR a property that is not the purchaser's primary residence (e.g. vacation home, second home, investment property).

Lets go over some examples involving a primary residence.

Example Number 1 (One Loan): Assume John Doe borrows $415,000 from a lender to purchase a condo for $435,000 with $20,000 down. John Doe falls behind on his payments and the bank initiates the foreclosure process. The condo is ultimately sold for $350,000 leaving the lender in the hole $65,000. This $65,000 loss is referred to as a deficiency. In this example, John Doe can just walk away because the loan was a purchase money mortgage which John Doe used to acquire a residential property that John lived in.

Example Number 2: (First and Second Loan) : Assume John Doe borrows $417,000 as a conforming loan and $300,000 as a second to purchase a house to be used for his primary residence for $767,000 with $50,000 down. John Doe falls behind on his payments and the bank initiates the foreclosure process. The home is ultimately sold for $650,000 leaving the lender in the hole $67,000. This $67,000 loss is referred to as a deficiency. In this example, John Doe should be able to walk away because all of the loan money was used to purchase a primary residence; however, John should retain a local attorney because the lender will attempt to get around California's Code of Civil Procedure Section 580(b) by arguing the loan transaction was not a standard transaction.

Example Number 3 (First Deed of Trust and Second Deed of Trust on a HELOC): Assume John Doe borrows $417,000 as a conforming loan to purchase a home and $100,000 as a second loan to make improvements to the home which will be used as his primary residence. John Doe falls behind on his payments and the bank initiates the foreclosure process. The home is ultimately sold for $400,000 leaving the lender(s) in the hole $117,000. This $117,000 loss is referred to as a deficiency. In this example, John Doe should be able to walk away from the $17,000 because the first loan was a purchase-money loan, but John will owe the second lender $100,000.because the holder of a second deed of trust on a HELOC has the right to sue the borrower should a foreclosure by the senior mortgage lender cut off its interest in the collateral. (if this is your situation you should contact both a real estate and bankruptcy attorney to determine which course is best for you.

Example Number 4 (Refinance): Assume John Doe borrows $250,000 from a lender to purchase a condo for $275,000 in 2001. In 2005, John Doe refinances the property to pull some money out and gets a loan for $400,000. In 2006, John falls behind on his payments and the bank initiates the foreclosure process. The condo is ultimately sold for $350,000 leaving the lender in the hole $50,000. This $50,000 loss is referred to as a deficiency. In this example, John Doe will owe the lender the $50,000 deficiency, because the loan (a refinance) was not used to acquire the property.

Now lets go over an example involving a vacation home.

Example Number 1 (Vacation Home or Investment Property):
In the above 4 examples we assumed the property foreclosed on was the primary residence of the borrower. If the property foreclosed on is a second home, a vacation home, or an investment property the owner will owe the lender any deficiency (the difference between the outstanding balance owed to the lender and the amount the lender received at the foreclosure sale). There is no anti-deficiency protection for vacation homes, second homes, or investment properties.