Security First Rule Can Be a Protection

With the 2006 downturn in the market, lots of homeowners found their home was worth less than they owed on it.  Sometimes these owners ran into financial trouble due to illness, divorce, or loss of employment.  When this happened, those owners often couldn’t make their monthly mortgage payments.

When the market was good, these homeowners had several options.  Because of rapid and significant market appreciation, owners often had substantial equity when trouble arose in their home after holding it for a short period of time.  If they couldn’t make their payments, such owners could sometimes refinance their home and borrow against their equity, which would provide them with cash for living expenses and mortgage payments.  If they couldn’t qualify for a refinance loan, then they could sell their property and cash out their equity.

When the market went down, all that changed. Because of the economic downturn, many owners found themselves “upside down” in their properties, with their home being “under water.”  The terms “upside down” and “underwater” are commonly used to refer to properties where the mortgage debt is more than the property value.

California has a “Security First” rule.  In most cases this means that a lender can’t ignore a mortgage and sue directly on a loan.  When a property is “underwater,” then if a borrower has assets other than real estate, a lender might prefer to ignore the mortgage and sue directly on the promissory note.  When borrowers take out a mortgage loan, they sign a promissory note whereby they agree to make monthly payments.  If there is little or no equity in a property, the lender might prefer to just ignore the mortgage and sue the borrower on promissory note.  But California law usually won’t allow this, because of the “Security First” rule.  California requires a lender to foreclose on a mortgage before looking to a borrower’s other assets.  This rule can help protect a borrower’s other assets by requiring a lender to first foreclose a mortgage on real property before looking to a borrower’s other assets.