By Jones Osborn II

The collapse in home prices has left many homeowners owing more on their personal residence than it is worth. Because of this, many homeowners are on the verge of defaulting on their home mortgage, and are wondering if the lender can sue them if they do.

The General Rule. The general rule, which applies in most cases, is that the lender can not sue a borrower who defaults on his or her home mortgage. This is because Arizona has an anti-deficiency law that protects homeowners, in the great majority of cases, from personal liability in the event they default on their mortgage.

In order to enjoy the benefit of this law, however, the mortgage (which, for purposes of this memo, includes a deed of trust) must be secured by property no larger than 2.5 acres in size that is "limited to and utilized for either a single one-family or single two-family dwelling." A condominium unit qualifies, even though it may be part of a development with a large number of units, as long as the mortgage encumbers no more than two units. And clearly, the typical single family home or townhouse qualifies. On the other hand, a mortgage loan secured by raw land or a commercial property does not.

It is not necessary for the dwelling to be the principal residence of the borrower. It can be a vacation home, or even a rental unit. Furthermore, it is not necessary for the property to actually be occupied at the time, so long as construction has been completed and it is suitable for occupancy. Thus, even though the statute states that the property must be "utilized" as a dwelling, this means only that it must be suitable for being so utilized. The owner is therefore entitled to the statutory protection even after vacating the property.

The Exception. There is an important exception to the general rule. If the mortgage is not a "purchase money mortgage," the lender can, if it proceeds in a certain manner, obtain a personal judgment for the obligation.

The key is the definition of "purchase money mortgage." Under Arizona law, a mortgage is considered to be a purchase money mortgage only if the proceeds are used to purchase the residence which secures the loan. For example, if a home equity loan is taken out to purchase a boat, it is not a purchase money mortgage. Or, if a mortgage is placed on an owner's principal

residence in order to obtain money used to purchase a different property, such as a vacation home or rental, it is not a purchase money loan.

It is important to note that if a purchase money mortgage is refinanced and replaced with a new mortgage, the new mortgage is still considered a purchase money mortgage. This is true even if the loan is refinanced for more than the original loan and the extra money is used for other purposes, and even if the new mortgage is from a different lender.

As mentioned above, a lender must proceed in a certain manner in order to obtain a personal judgment for a non-purchase money loan secured by a qualifying residence. Specifically, the lender must either (a) waive its security and sue on the note, or (b) conduct a judicial foreclosure of its mortgage and then sue for a deficiency. If the lender forecloses by conducting a non-judicial trustee's sale, which is the most common way to foreclose, the anti-deficiency law applies and the lender cannot take further action against the borrower.

Second Mortgages. The foregoing rules apply to both first and second mortgages. They also apply to so-called "wiped-out seconds," which are second mortgages which have been voided by the foreclosure of the first. In such a case, the creditor holding the wiped-out second mortgage cannot sue to collect on its loan except in the case of a non-purchase money obligation or when the loan is not secured by a qualifying single or two family dwelling.

Conclusion. In most cases, a homeowner cannot be held personally liable for the repayment of the mortgage on his or her personal residence. However, if the homeowner has taken out a home equity loan and used the proceeds for something other than the purchase of the home or refinancing an existing purchase money loan, there can be personal liability for the repayment of that loan.

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A.R.S. §33-729; A.R.S. §33-814; Baker v. Gardner, 160 Ariz. 98, 770 P.2d 766 (1988); Mid Kansas Fed. Sav. & Loan Ass'n. v. Dynamic Dev. Corp., 163 Ariz. 233, 787 P.2d 132 (App. 1989), vacated 167 Ariz. 122, 804 P.2d 1310 (1991); Resolution Trust Corp., v. Segel, 173 Ariz. 42, 839 P.2d 462 (1992); Nydam v. Crawford, 181 Ariz. 101, 887 P.2d 631 (1994).