This will come as a shock to most homeowners, who generally assume that the most they stand to lose if they cannot pay is the house itself. What is this all about?

The law in question, noted in section 580b of the California Code of Civil Procedure was written in the 1930’s to protect homeowners from having everything taken from them by their creditors during a time when many people were defaulting on their loans. The law applies to first mortgages only - the loan initially taken out to buy the home. Subsequent loans, such as a refinancing, do not apply.

The law seldom comes into play, as it requires the lender to file for a judicial foreclosure through the court system. This procedure is rarely used, as it requires lawyers and time and money. Most lenders don’t bother to go this route, so the law rarely comes into play. Homeowners who refinance should be aware, however, that this possibility exists. There is nothing to prevent a mortgage company from going that route should foreclosure become necessary. Furthermore, if a lot of people start to default on their loans, and that’s a real possibility as housing prices are starting to decline, lenders could elect to foreclose through the courts as a matter of course.

Housing prices began to decline last month and homes are beginning to stay on the market longer, even in “hot” real estate markets. Should a large overall price decline come about, lenders may be looking at a large number of foreclosures on property that is financed for far more than its current market value. That could force their hands, leading to more and more judicial foreclosures. 

This law applies primarily to California. We are not currently aware of any other states that have such a law on the books.