It is no secret that the number of Arizona foreclosures that has sharply increased since the real estate crash began in 2007. Along with the rise in foreclosures has come an increase in lender lawsuits seeking deficiency judgments against former homeowners.

A “deficiency” occurs when a lender sells a foreclosed property for less than the amount that is owed against it. For example, if the borrower owes $150,000 on a home that, after foreclosure, sells for $100,000, the amount of the deficiency would be $50,000.

Anti-Deficiency Protection. In an effort to protect homeowners in foreclosure, during the last two decades the Arizona legislature passed A.R.S. §§ 33-729(A) and 33-814(G), generally known as Arizona's "anti-deficiency statutes." Specific to this discussion, A.R.S. § 33-814(G) prohibits foreclosing lenders from pursuing a deficiency judgment after the foreclosure of a single one- or two-family dwelling that occupies 2½ acres or less. While this protection may seem fairly straightforward, there are certain intricacies and limitations that the homeowner must be aware of before permitting a foreclosure to occur, or else face potential financial liability for the balance of the loan after the sale.

While Arizona’s anti-deficiency statutes provide a certain amount of protection for the homeowners against these sorts of lawsuits, real estate lenders are becoming increasingly sophisticated in trying to circumvent those protections. Therefore, for many homeowners facing foreclosure it is vital to understand – before the foreclosure process begins – the anti-deficiency statutes and the potential holes in the protection they are intended to provide.

Pitfalls

First, and most important, the protections afforded by Arizona’s anti-deficiency statutes are generally available only in the case of “purchase money” security interests, i.e., security interests that secure the purchase price of the property.¹ If a homeowner takes out a loan for purposes other than the purchase of the house (for example, refinanced funds used for remodeling or other purposes), the homeowner may be liable to the lender, after foreclosure, for the unpaid portion of the loan. In other words, depending on the specifics of the case, anti-deficiency protection may not be available to  homeowners who used loan proceeds for purposes other than to buy the house.

Another potential (but yet to be litigated) pitfall is the utilization requirements of A.R.S. § 33-814(G). That statute provides that anti-deficiency protection is available for qualified properties that are “utilized” as single one- or two-family residences. While there is no clear decision on this issue, it is certainly conceivable that this language requires that the property continue to be occupied up until the foreclosure sale. Otherwise, if the property is abandoned prior to the sale, it can be argued that it is not being utilized as envisioned by lawmakers and therefore is not entitled to the law’s protections.

A third potential pitfall, attributable to banks’ increasing sophistication and desire to cut their losses, is the danger of pre-foreclosure “setoff.” To lessen the loss caused by anti-deficiency protection, many lenders are attempting to garnish – prior to the sale of the foreclosed property – the accounts held by the homeowner at that institution. In other words, banks are taking any and all money they can get their hands on prior to the foreclosure sale, knowing that the opportunity will be lost after the sale occurs.

Be Prepared

All of these potential pitfalls result in an inescapable conclusion: the foreclosure process is complicated and fraught with risks. The good news is that there are steps that many distressed homeowners can take to avoid the above-mentioned pitfalls and benefit from the protections of A.R.S. § 33-814 – as long as they are aware of those steps.

Thus, before even considering foreclosure, it is imperative that homeowners become intimately familiar with the foreclosure process and fully understand how the laws will apply to their specific situation.