The Arizona Legislature has made a change to foreclosure law that could, when it takes effect, be very important to owners of rental houses. In the regular session that ended earlier this summer, the Legislature adopted a change to a statute, last amended in 1990, that protects borrowers from liability for a deficiency after foreclosure on a single family house or a duplex on less than 2 1⁄2 acres. When the value of property taken by a lender in a foreclosure is less than the amount the borrower owes the lender, that difference is the deficiency. Here is how the Legislature amended the statute (the new parts are in ALL CAPS):

If trust property of two and one-half acres or less which is limited to and utilized for either a single one-family or a single two- family dwelling BY THE TRUSTOR UNDER THE DEED OF TRUST FOR AT LEAST SIX CONSECUTIVE MONTHS AND FOR WHICH A CERTIFICATE OF OCCUPANCY HAS BEEN ISSUED is sold pursuant to the trustee’s power of sale, no action may be maintained to recover any difference between the amount obtained by sale and the amount of the indebtedness and any interest, costs and expenses. THE TRUSTOR IS RESPONSIBLE FOR DEMONSTRATING THAT THE TRUST PROPERTY WAS USED BY THE TRUSTOR AS A ONE-FAMILY OR A SINGLE TWO-FAMILY DWELLING FOR AT LEAST SIX CONSECUTIVE MONTHS.

In the past, the law was that if a lender used the trustee sale method of foreclosure, the lender could not collect a deficiency from the borrower for any property less than 2 1⁄2 acres that had one house or one duplex on it, even if the house or duplex was occupied by someone other than the borrower (e.g. a rental property) or was unoccupied. With the stuff that the Legislature added, the statute now means that if the lender uses a trustee sale, the lender can collect a deficiency unless the borrower (“trustor” in the statutory lingo) demonstrates that the borrower occupied the property as a dwelling for at least six months. In other words, borrowers with deeds of trust on rental (or unoccupied) houses are no longer protected from deficiencies.

One thing the new law doesn’t say that appears to mitigate its impact is that it doesn’t say when the borrower must have occupied the property for six consecutive months. I suppose that means that if the borrower bought the house, lived in it for six months, then moved out but continued to own the house as a rental property (or left it vacant), the borrower would not be subject to a deficiency. That narrows the impact of the statute at least somewhat, since there are undoubtedly a substantial number of houses that were formerly occupied by the owners but are now rented or vacant. The change in the law only affects those owners who have never occupied the property as a dwelling for at least six consecutive months.

The Legislature, in their infinite wisdom, apparently did not see fit to make the same changes to another statute that prohibits a lender from collecting a deficiency when the loan was used to purchase the property, even if the lender used a judicial foreclosure (a lawsuit) rather than a trustee sale to take back the property. This means (I think) that if the loan being foreclosed was not used to purchase the property (i.e. a home equity loan), the borrowers are still vulnerable to a deficiency if the lender elects to use a judicial foreclosure, even if the house is owner-occupied. If on the other hand the house is not owner-occupied, the lender can use a trustee sale and pursue a deficiency even if the loan was used to purchase the property. Got it?

From what I read in the newspapers, there is an effort underway to get the Legislature to reverse itself and repeal the change that was just adopted before it takes effect. That would require the cooperation of the Governor so that the Legislature could consider the matter in special session. If that doesn’t happen, the amendment takes effect in October, 2009.