The answer to this question is complicated and depends upon the particular circumstances of each short sale. Whether a lender can justifiably retain legal rights to collect a deficiency from a short sale depends upon a number of factors, such as the state where the property is located, the priority position of the loan (first or second), the character of the loan (recourse or non-recourse), the nature of the property (residential or non-residential), type of ownership (owner occupied or non-owner occupied), and what method of foreclosure the lender pursues (judicial or non-judicial).

Generally, a lender pursuing non-judicial foreclosure (i.e., a trustee’s sale) on a first loan secured by residential property in California should not be granted a deficiency right in a short sale because the lender would not be entitled to pursue a deficiency judgment in the event of a foreclosure.  In other words, a lender should not receive a deficiency right in a short sale under circumstances where the lender would not be entitled to the same deficiency right in a foreclosure. If the lender does make such demands in a short sale, the homeowner is better off to simply walk away and let the property go to trustee’s sale after which they will owe nothing. This is why it is critical to have legal representation in a short sale.

Second loans, however, are a different story. Generally, second loans are recourse loans unless the loan was used strictly to purchase a primary residence, in which case it would be a non-recourse loan. In most cases, a second position lender will receive only a minimal payoff from the proceeds of a short sale. This payoff amount is mainly provided as a financial incentive for the second position lender to release their lien against the property so the short sale can be completed. Thus, second position lenders will typically retain deficiency rights to collect the balance owed on the loan after a short sale closes escrow if the loan is recourse.