LAYING DOWN THE LAW – It’s All About The [Purchase] Money: Are Construction & Home Improvement Loans Entitled to Anti-Deficiency Protection?

Christopher J. Charles, Esq. Provident Law	Phillip A. Overcash, Esq. Provident Law

Arizona law provides certain protections to homeowners who obtain purchase money financing for a home and then subsequently default. There are, however, important limitations to those protections.

The Arizona Court of Appeals recently held that, generally, construction loans qualify as a purchase money obligation when the deed of trust securing the loan covers the land and the dwelling constructed on the property, and is therefore entitled to anti-deficiency protection under A.R.S. §33-729(A). However, a construction loan used to build a residence is significantly different for this purpose from a loan used to improve an existing home, and a home improvement loan will not be entitled to anti-deficiency protection. Arizona courts will take a very close look at the nature of the use of the loan to determine whether it was used to construct the residence, or whether it was used to merely improve the residence.

A.R.S. § 33-729(A) provides:

…if a mortgage is given to secure the payment of the balance of the purchase price, or to secure a loan to pay all or part of the purchase price, of a parcel of real property of two and one-half acres or less which is limited to and utilized for either a single one-family or single two-family dwelling, the lien of judgment in an action to foreclose such mortgage shall not extend to any other property of the judgment debtor, nor may general execution be issued against the judgment debtor to enforce such judgment, and if the proceeds of the mortgaged real property sold under special execution are insufficient to satisfy the judgment, the judgment may not otherwise be satisfied out of other property of the judgment debtor, notwithstanding any agreement to the contrary.

To simplify, the anti-deficiency protection provides that if a borrower uses mortgage loan proceeds to purchase or construct a dwelling on a parcel of real property of two and one-half acres or less which is limited to and utilized for either a single one-family or single two-family dwelling, the lender can only seek recovery from the sale of the property, and may not seek a deficiency judgment against the borrower from any other assets. However, problems arise when mortgage loans are used to improve pre-existing property, rather than to construct a new dwelling.

The Arizona Court of Appeals recently ruled that “a construction loan will qualify as a purchase money obligation when the deed of trust securing the loan secures the land and the dwelling constructed on the property, and the loan proceeds were used to construct a dwelling that meets the size and use requirements of § 33- 729(A)…. [H]owever… a construction loan used to build a residence is significantly different for this purpose from a loan used to improve an existing home.… Although a construction loan may fall within the anti-deficiency statute, a home improvement loan will not.” Helvetica Servicing, Inc. v. Pasquan, 1 CA-CV 17-0699, 2019 WL 3820015, at *3 (App. Aug. 15, 2019)(internal citations omitted).

In that case, the borrower obtained numerous loans to purchase and renovate a 4,000 square-foot home in Paradise Valley. Some of those loan proceeds were used to payoff other loans on the property, while the remainder of the proceeds went toward the renovation/expansion project (including adding a game room, two bedrooms, a kitchen, and a bathroom), and later landscaping, maintenance, taxes, utilities, and marketing. The borrower defaulted, and the lender sued to judicially foreclose on the property. The Superior Court entered a sizeable deficiency judgment against the borrower in the amount of nearly $2 million.

After other proceedings, the trial court held that the portion of the loan used to refinance an earlier loan was a purchase money obligation entitled to protection under A.R.S. § 33-729(A). The lender agreed with that ruling but argued that the amounts used to finance home improvements were not “home construction” entitled to such protections.

The Arizona Court of Appeals held that “a construction loan used to build a home that secures the debt qualifies as a purchase money loan for anti-deficiency protection

under § 33-729(A) and refinancing a purchase money loan does not destroy the original loan’s status.” “Further, when loan proceeds are used for ‘both purchase money and non-purchase money sums, a lender may pursue a deficiency judgment for the latter amounts’ if they can be traced and segregated.” Id. The Court of Appeals further held that “points, interest, and reserves” paid in connection with the loan were entitled to anti-deficiency protection.

In this case, however, the proceeds used to remodel the property were not entitled to such protection, and the lender could pursue against the borrower personally the deficiency between the outstanding balance on the loan and the proceeds from the judicial foreclosure sale.

If you or someone you know has questions regarding Arizona’s anti-deficiency statutes, or any other mortgage-related issue, call our office to schedule a consultation with Attorney Philip A. Overcash or Christopher J. Charles.

Philip A. Overcash is an Attorney with Provident Law®. Mr. Overcash practices in the areas of complex commercial and real estate litigation. He has successfully represented numerous international, national and Arizona-based corporations and individuals, government entities and insurance companies in a wide array of legal disputes involving real estate, contracts, construction defects, insurance coverage and bad faith, employment law, trademark and trade secrets, and appeals. Philip is admitted to practice in Arizona’s State and Federal Courts, and he is a Member of the Arizona State Bar Association and Maricopa County Bar Association. He can be reached via email at philip@providentlawyers.com or at 480-388-3343.

Christopher J. Charles is the Founder and Managing Partner of Provident Law®. He is a State Bar Certified Real Estate Specialist and a former “Broker Hotline Attorney” for the Arizona Association of REALTORS® (the “AAR”). He is also an Arbitrator and Mediator for the AAR regarding real estate disputes; and he served on the State Bar of Arizona’s Civil Jury Instructions Committee from 2011-2015 where he helped draft the Agency Instructions and the Residential Landlord/Tenant Eviction Jury Instructions. Christopher is a licensed real estate instructor and he teaches continuing education classes at the Arizona School of Real Estate and Business. He can be reached at chris@providentlawyers.com or at 480-388-3343.