Sometimes knowing a little about a topic is more dangerous than knowing nothing. The Arizona Anti-Deficiency Statute is like this. There are two of them. If you don’t know both of them, you would be better off not knowing either. That way you wouldn’t think you have the answer when you don’t.
The most common situation I come across is meeting with a prospective client who believes that are going to owe a lot of money after their property in Arizona goes into foreclosure. Someone has told them that only a short sale will prevent the lenders from coming after the homeowner for a deficiency. This is wrong.
Arizona Anti-Deficiency Law Rule 1
A short-sale has some advantages, but it is not to avoid a deficiency claim by the lender. Arizona has two anti-deficiency statutes. One of them states that if a mortgage company forecloses on residential property in Arizona they cannot collect a deficiency. It makes no difference whether or not the borrower lived in the property. It doesn’t matter whether or not the mortgage loan was used to buy the property (a purchase money mortgage). The only thing that matters is whether the property was residential, a house, and whether the lender foreclosed.
Arizona Anti-Deficiency Law Rule 2
The second anti-deficiency statute says the borrower cannot be sued to collect on a loan that was used to buy a home in Arizona. This is often called a “non-recourse” loan. The loan must be a “purchase money” loan. That means that the loan proceeds were used to buy the house. The property must be residential property. That property must be on a lot no larger than two and one-half acres.
What’s Not Covered?
A second mortgage taken out after you already own the home is a problem. A Home Equity Line of Credit (HELOC) is never a purchase money loan. The second rule does not apply; it is not a purchase money mortgage. The first rule does not apply unless the second mortgage holder is the one who forecloses. When the first mortgage forecloses, the second mortgage is still a personal liability. Neither one of the Arizona Anti-Deficiency rules cover this situation.
What About the Tax?
You may have heard about a tax for forgiveness of debt. A lender cannot forgive a debt that you do not owe. When either one of the above Arizona Anti-Deficiency statutes apply there is no debt to cancel. There will be no income tax as a result. I know you have heard different. The IRS agrees with me on this one. You can read IRS Publication 4681 for all the details.
What to Do
Before deciding whether to put time and money into a short-sale, file a bankruptcy, settle with second mortgage holder, or walk away from your mortgage, get the facts. The problem I see repeated over and over is advice that was given based on one of the statutes being applied to the wrong facts. It is wrong. The time and expense invested in learning what the real rules are and applying them to your specific situation is a drop in the bucket compared to the grieve and unnecessary expense of relying on second hand or wrong advice.
Image credit: Caveman Chuck Coker
