Washington's Homestead Exemption to See Major Increase With Proposed Legislation
Summary of Proposed Legislation & Effect on Commercial Lenders
On March 2, 2021, Washington’s Senate passed SB 5408, which proposes major changes to Washington’s current homestead exemption. Most significantly, the legislation proposes to substantially increase the homestead exemption from the current $125,000 to the county median sale price of a single family home in the preceding calendar year. The county’s median sale price is to be determined using an index from the Runstad Department of Real Estate at the University of Washington. In King County, for instance, this would mean the new homestead exemption for someone filing bankruptcy today would be $724,950, a nearly sixfold increase (based on Seattle Times data).
As currently proposed, Washington’s new legislation regarding an increased homestead exemption will either protect a debtor from a forced sale or severely curtail the distributable net proceeds following a forced sale in bankruptcy. However, the new proposed exemption will not change the application of the homestead exemption when a commercial lender nonjudicially forecloses a Deed of Trust granted by a guarantor. The increased homestead exemption may change the credit approval process to ensure a commercial lender has adequate, accessible collateral securing the loan in the event of a guarantor bankruptcy. In that regard, this change in the law should be understood by both loan officers who rely on personal residences as collateral and by special assets officers as well.
Potential Impacts to Commercial Lenders Regarding Collection of Delinquent Commercial Loans
Where lenders have Deeds of Trust securing their commercial loans, lenders can continue to foreclose nonjudicially on that commercial property without application of the proposed homestead exemption, and on the borrower or guarantor’s individual property. Recall, however, that there is a current $125,000 homestead exemption for business guarantors. RCW 61.24.100(6). That exemption is not changed by the proposed legislation.
Only where a lender pursues a judicial foreclosure, or when an individual borrower/guarantor files bankruptcy, will the new homestead exemption come into play and potentially impact the lender’s ability to collect. The new proposed homestead exemption will have the most impact where a borrower or guarantor files bankruptcy.
For example, consider a King County guarantor who files bankruptcy, owning a residence worth $1.2 million in King County with $400,000 of equity in the home. Under current law, only $125,000 of that equity would be exempt, such that a sale within the bankruptcy could generate $275,000 for unsecured creditors, and creating incentives for a Trustee to sell the property. In contrast, under the proposed legislation, 100% of the guarantor’s equity in the home would be exempt based upon the King County median home value of $724,950, and the trustee would not force a sale of the home because there would be no non-exempt portion. Thus, whether such a loan is secured by a Deed of Trust or not, if a guarantor files bankruptcy under the foregoing scenario and proposed legislation, no recovery in the bankruptcy would be obtained by the lender through the bankruptcy process.
In another scenario, if debtor only owed $200,000 on the $1.2 million residence, and had equity of $1 million, the non-exempt portion would only be $275,000 (whereas it would have been $875,000 under current law). Given the $275,000 of nonexempt equity, the trustee could sell the property. While the lender would be able to recover if the loan was secured by a DOT on the property, in other situations, the lender would only be entitled to a pro rata share of the $275,000 non-exempt proceeds while the debtor would retain approximately $725,000 (the King County exemption amount). Debtor could take the $725,000 and buy a new $1.2 million property with a new mortgage, with the original lender unable to access the debtor’s equity to satisfy any outstanding indebtedness. These possibilities may mean that more borrowers/guarantors will file bankruptcy to halt nonjudicial foreclosures given the substantial asset protection the new exemption could provide.
It is also important to note that while the debtor’s homestead exemption value is determined as of the date of bankruptcy filing, the proposed legislation provides that any additional appreciation after the bankruptcy filing is also exempt even if it exceeds the statutory amount. To illustrate: consider a King County debtor who owned a home worth $1.2 million on the date of filing, owed $475,000 on it, and was therefore entitled to a homestead exemption for all of the equity as of the date of filing ($725,000 based on King County median home value, which is the current exemption maximum). During the pendency of the debtor’s bankruptcy over the next year, debtor’s home value increases by 12.5%, or $150,000, to $3.35 million. Under the proposed legislation, the additional $150,000 in annual appreciation would also be exempt, even though debtor’s equity in the home a year later exceeds the otherwise allowable homestead exemption of $725,000. Thus, the legislation gives the debtor the benefit of any additional appreciation rather than a creditor/lender.
Status of Legislation & Recommendations
Given the potential adverse effect of the increased exemption on a commercial lender’s ability to collect upon a borrower or guarantor’s bankruptcy filing, going forward, lenders will need new analyses of credit risk and plans to obtain adequate collateral to secure the loans if the proposed legislation is enacted. Lenders may want to consider other forms of collateral, such as personal property (nonexempt), and for real property, to seek Deeds of Trust on non-residential property (to avoid homestead claims entirely), as well as non-agricultural property (to ensure nonjudicial foreclosure remains an option). Further, when considering forbearance agreements, lenders may want to reassess the adequacy of existing security/collateral in light of the new proposed exemptions to determine whether to require an additional Deed of Trust or other additional security as a condition of entering into a forbearance agreement.
The bill has currently passed the Senate and is under consideration in the House. While one cannot predict whether the new homestead exemption legislation will be enacted, it was passed by an overwhelming majority of the Senate, and closely tracks a similar bill recently passed in California, so enactment seems fairly likely. Given this possibility, lenders should start planning now for any new loans and review existing loans for the adequacy of non-exempt security with an eye toward the likely passage of an increased homestead exemption.
If you have questions about the pending legislation or the homestead exemption, contact a member of the Stokes Lawrence Financial Services practice.