Does Loan Modification turn your Mortgage into Recourse Debt?

I have been asked this question several times in the recent past. I have always told Real Estate professionals that as long as the the original purchase money deed of trust is recorded on the property, the lender has no recourse. In LA last week I had a couple agents put up a very excellent argument on why the debt should become recourse. I decided to do the research beyond my own suspicion and seek the advice from a REPUTABLE attorney!

Under California law (Civil Code Section 580b), if a lender makes a loan to enable a borrower to buy a 1-4 unit property which they live in, the lender has no recourse against the borrower. They can only take (foreclose) the property. They cannot get a judgment against the borrower if the property is not worth the amount owed on the loan. This is called an “acquisition loan”. If the borrower later refinances this loan by getting a new loan, this protection is generally lost because the new loan was not obtained to acquire the property. That makes sense. But what about a loan modification?

Recently, several clients have had lenders (or collection companies) tell them that their loans became recourse because they got a loan modification. From what I can see, this appears to be false and is no doubt said in an attempt to collect some money even when there is no recourse.

The First reason that this is false is that the loan and security (deed of trust) have not changed. It is still the acquisition loan and the same date of purchase recorded security. Second, there is a rule in law called “substitution”. The substitution doctrine applies when an acquisition loan is refinanced by the lender holding the original acquisition debt. The acquisition portion refinanced retains its purchase money character and the anti-deficiency protections of CCP §580(b) apply. (Union Bank v. Wendland, 1976). Further there is legal authority that the protection extends to situations where the “beneficiary of the purchase-money loan ‘refinances’ the loan, ie: same lender, borrower, and security, but different loan amount. From these sources, it appears fairly clear that a modification will not alone convert a non-recourse acquisition loan into a recourse loan. As the court said in the Union Bank case, “…. the protections of the anti-deficiency statutes can not be avoided because of some clever paper shuffling on the part of the lender. To allow such is a circumvention of the anti-deficiency statutes.”

It was also clearly outlined to me that if the lender did try to actually seek a judgement a trial could easily be attained. With that said any first year internet attorney could win that case by illustrating the unpopular lender practices now perceived by the American public as villainous.

-Christopher Rockey