Court of Appeals Clarifies the Application of Arizona’s Anti-Deficiency Statute to Construction Loans and Refinances
By Kelley L. Cathie, Braun Siler Kruzel PC

Under Arizona’s anti-deficiency statutes, a borrower of a purchase money loan (i.e. a loan used by a borrower to purchase a residential property) who purchases a single family (or two family) residence of 2.5 acres or less is not personally obligated for the amount of the loan in excess of the value of the real property and residence that secures the loan. However, as a result of Arizona’s housing collapse and corresponding economic downturn, questions have arisen regarding the applicability of the anti-deficiency statutes to construction loans, refinances and loans that mixed both purchase money and non-purchase money uses. In two recent cases, the Arizona Court of Appeals has provided some substantial aid to explaining the anti-deficiency protection to construction loans and refinances..

Construction Loans Can Qualify For Anti-Deficiency Protection

Through its decisions in M&I Bank v. Mueller, 1 CA-CV 10-0804, filed December 27, 2011, and Helvetica Servicing, Inc. v. Pasquan, 1 CA-CV 10-0418, filed March 20, 2012, the court made clear that construction loans for personal residences qualify as purchase money loans even if the home was never completed or lived in provided that: (1) the Deed of Trust securing the loan covered both the real property and the dwelling constructed, or to be constructed, thereon; (2) the property secured by the Deed of Trust meets the other requirements of the anti-deficiency statute (i.e. 2.5 acres or less and used as a one or two family residence); and (3) the borrower purchased the property with the intent to occupy the property upon completion of construction.

Note however, that in Helvetica the court made a point of distinguishing between construction loans and home improvement loans, stating that its ruling was only addressing the applicability of anti-deficiency protection to construction loans. The issue of the applicability of anti-deficiency protection home improvement loans on existing residences remains unclear.

Refinanced Purchase Money Loans Do Not Lose Purchase Money Status if Purchase and Non-Purchase Money Uses Can be Segregated

In Helvetica, the court also confirmed that a borrower’s refinance of an existing purchase money loan does not alter the character of the loan for purposes of the applicability of the anti-deficiency laws to the extent the proceeds from the refinance are used for a purchase money obligation. Arefinanced loan continues to have anti-deficiency protection to the extent that the proceeds from that loan were used to pay off the prior purchase money loan.

The court went on to address the all too common situation where a borrower uses a loan for both purchase money and non-purchase money purposes, finding that such non-purpose money portions of the loan can be segregated out and subject to deficiency judgments by the lender. For example, a borrower refinanced his home for $400,000 to pay off his original $300,000 purchase money loan, but also used the remaining $100,000 loan proceeds from the refinance to pay off other, unrelated non-purchase money purposes (i.e. paid off higher interest debts such as credit cards, cars, etc.). In such circumstances, the court’s recent holding in Helvetica dictates that the $100,000 non-purchase money portion of the loan proceeds can be segregated from the purchase money portion of the loan. Under this system, the $300,000 purchase money portion of the loan would retain its purchase money status and thus its protection under Arizona’s anti-deficiency laws. The $100,000 non-purchase money portion of the loan would not be protected by the anti-deficiency laws and would be subject to the lender’s right to seek a deficiency judgment for such funds.

These recent court decisions bring long awaited answers and some certainty to important anti-deficiency questions. However, questions remain regarding additional legal interpretations and applications of these statutes, particularly in Arizona’s current economic climate. If you have questions regarding the application of the anti-deficiency laws to your property or have other real estate related questions, please contact Kelley Cathie at 480-367-3376 or kcathie@bskazlaw.com.