Foreclosure Deficiency: Construction Loan vs. Home Improvement Loan

In a recent Arizona Court of Appeals case, Helvetica Servicing, Inc., v. Pasquan, 2019 WL 3820015, (8/15/19), the Court of Appeals addressed the distinction between (1) a construction loan (or refinance of same) and (2) a home improvement loan (or refinance of same), as it relates to Arizona’s anti-deficiency statute, A.R.S. §33-729(A).

In general, an anti-deficiency statute provides that although a purchase-money lender or a construction lender can – in appropriate circumstances – foreclose on their loan and cause a sale of the property to pay the loan, the lender cannot (if the statutory criteria are met) force the homeowner/borrower to pay the remaining balance still owed on the loan following the foreclosure (known as the deficiency). In other words, if the anti-deficiency rule applies, the lender’s sole remedy to collect on the loan is a foreclosure sale of the property; and the homeowner/borrower’s downside risk is loss of the property in foreclosure; the homeowner/borrower does not have any personal liability to pay the remaining unpaid balance of the loan post-foreclosure. In effect, the homeowner/borrower can simply walk away and not have to repay the loan.

In Helvetica, the homeowner borrowed $600,000 from Lender A to purchase the 4,000 square foot house. The homeowner then borrowed $2.1 million from Lender B, a portion of which was used to refinance the original purchase money loan, with the remainder used to add another 7,000 square feet to the house. The homeowner then borrowed $3.4 million from Lender C, which refinanced the loan from Lender B, with the balance used to pay off other debts of the homeowner, plus pay for property maintenance, taxes, utilities, and marketing for sale.

Lender C ultimately foreclosed. The dispute focused on whether the funds used to build the additional 7,000 square feet and otherwise improve the house were to be considered a loan “used to construct a residence” (thus protected by the anti-deficiency statute) or “a home improvement loan” (thus not protected – making the borrower personally liable for that portion of the deficiency). The court held that the loan amount attributable to construction of the additional 7,000 square feet to the house was a “home improvement loan” (not a loan for construction of a residence), and thus not protected by the anti-deficiency statute.