California lawmakers are weighing legislation that would provide some protection from deficiency judgments for borrowers who refinanced their mortgages.

California already prohibits lenders from pursuing deficiency judgments against homeowners who default on their original purchase mortgage. Lenders can foreclose on the borrower’s home and attempt to recoup their losses by selling the property securing the loan. But if the sale doesn’t cover the amount owed, lenders can’t go to court to force borrowers to make up the difference.

The law barring deficiency judgments does not apply to refinancings, however, which were often used by homeowners during the boom to convert equity in their homes into cash.

SB 1178, which passed the state Senate in a 30-4 vote on June 3, would extend protection from deficiency judgments to homeowners who have refinanced, but only up to the amount of their original loan.

In other words, if the original mortgage was $300,000, and the homeowner refinanced and defaulted on a $350,000 loan, they would not be liable to repay the first $300,000.

Realtors support the bill because they fear many borrowers will be locked out of the housing market for years to come if they are hit with deficiency judgments, bill sponsor Sen. Ellen Corbett, D-San Leandro, told the New York Times.

Although it’s unusual for lenders to pursue deficiency judgments against borrowers, their right to do so can serve as a negotiating tool with borrowers seeking loan modifications or short-sale approvals, the Times reported.

"It is unfair to subject homeowners to new personal liability merely because they refinanced the original mortgage," the California Association of Realtors said in support of the bill. The unfairness "is particularly acute in that almost no borrowers understood the new liability that was being acquired along with the refinance."

The Center for Responsible Lending also supports the bill.

According to an analysis of the bill by staff members of the Senate Rules Committee, Corbett says the bill is intended to protect only borrowers who used cash from refinancing in order improve their property, rather than for other purposes, such as buying a car.

But lenders say it’s unclear whether the bill extends anti-deficiency protection to all proceeds of a refinance, or only the funds used to improve the property.

Opponents say the bill would perpetuate the same over-leveraging by borrowers that contributed to the existing mortgage meltdown.

Extending protection from deficiency judgments to homeowners who refinanced their loans could also encourage "strategic defaults" by borrowers who can afford to make their mortgage payments but choose not to because their home is worth less than they owe.

California lawmakers are also considering a bill, SB 1275, that would expand the pool of borrowers lenders are required to contact and consider for a loan modification before beginning foreclosure proceedings. SB 1275 passed the Senate June 3 in a 21-12 vote and has been referred to the Assembly Committee on Business and Finance.


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