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Your credit card debt shouldn’t cost you your home

Prasad Krishnamurthy, Professor of Law | May 7, 2020
various credit cards

(Photo: Nick Youngson | Alpha Stock Images — CC by-SA 3.0)

Co-authored by Miguel Soto, staff attorney at the East Bay Community Law Center and supervisor of Consumer Justice Clinic.

Did you know that your credit card debt could cost you your home? In California, unpaid credit card, medical, or other consumer debt can result in a court order to sell your home, even if you pay your mortgage. As consumer debts and defaults accumulate due to COVID-19, thousands of Californians will find themselves at risk of losing their homes. It is therefore high time that we pass California Assembly Bill 2463 and end the practice of forced home sales — outside of bankruptcy and foreclosure — to pay off consumer debt.

To see how such a forced sale can happen, consider a family that has lost a job or business and defaulted on their credit card debt. The lender can obtain a default judgment, record a lien on the home, and petition a court to order a sale. The court will then determine whether the market value of the home exceeds the amount owed on any mortgages plus the homestead exemption. The homestead exemption is the amount of money that a homeowner gets to keep before non-mortgage creditors get paid. In California, this amount is $100,000 for families. If the market value of the home is high enough, the court will order a sale. For example, suppose the mortgage on the property is $400,000. The court will order a sale if the home is worth more than $500,000, which is well below the state median.

Can’t the family get a second mortgage to pay off their credit card debt? Not if their application is denied because of their income or a lien on the property. Besides, even if they are successful, this is just borrowing from Peter to pay Paul. A default on the second mortgage will still cost the family its home, except now the foreclosing lender gets paid before the family no matter how high the homestead exemption. For these reasons, senior citizens with limited incomes and high-interest loans, often taken to help family members, are most at risk of losing their home to a forced sale even if they own it free and clear of a mortgage.

There are at least four reasons why we should protect all Californians and take the right of forced sale — outside of bankruptcy and foreclosure — away from consumer creditors. First, very few consumers are aware of this right. Second, the rights of mortgage and other secured creditors would be unaffected, as would the rights of unsecured creditors in foreclosure and bankruptcy. Third, revoking the right for consumer creditors preserves the right for other, more-deserving creditors such as guardians seeking child support and accident victims.

Finally, the current system is broken. A remarkable study of forced home sales by the East Bay Community Law Center reveals a stark pattern of small, zombie debts brought to life by debt purchasers and inflated by years of interest and fees; lack of adequate notice; mistaken identity; and disproportionate harm to low-income communities of color concentrated in Southern California. It also chronicles the courage of Californians like Ingrid, who fought her mother Laura’s case after she suffered a stroke, and Julio, an immigrant driver, who battled for three years to defeat a mistaken claim based on medical debt.

Of course, the likely response from lenders will be that limiting forced sales would be bad for consumers because it will raise interest rates for credit cards and other unsecured loans. But this is a one-sided view because it looks at credit supply while ignoring demand. Protection against a forced sale is like financial disaster insurance. If offered at a fair price, borrowers will be more than willing to pay for it. In fact, the evidence shows that when states raise their homestead exemptions, it actually increases the total amount of unsecured credit with no effect on delinquencies. Limiting forced sales should produce similar but smaller effects.

Californians should have the right to keep their homes if they can avoid foreclosure and bankruptcy. Otherwise, once the shelter-at-home orders end, thousands of Californians will find themselves at risk of losing the very homes that sheltered them.

An abridged version of this commentary was originally published in the San Francisco Chronicle.