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Arizona Significantly Alters Homestead Exemption and Judgment Lien Rules

Pratt's Journal of Bankruptcy Law Gabriel M. Hartsell, Madison Stark

In this article, the authors discuss a new Arizona law that, among other things, increased the homestead exemption from $150,000 to $250,000—but that offers homeowners fewer protections against judgment creditors than prior law.

A new law, HB 2617, has significantly altered the homestead exemption under Arizona law.

BACKGROUND
Under prior law, up to $150,000 in equity proceeds in a debtor’s home was exempt from collection by creditors.

Additionally, the homestead exemption prevented judgment liens from attaching to a debtor’s homestead property: “[A] recorded judgment shall not become a lien on any homestead property. Any person entitled to a homestead on real property as provided by law holds the homestead property free and clear of the judgment lien.”

The homestead exemption operated to protect Arizona homeowners up to $150,000 in equity they may have in the property, and to allow them to sell their homestead property free and clear of any judgment lien, and without notice to any judgment creditor. If a judgment creditor wanted to collect against the homestead property, it had to obtain a writ of execution and ask the sheriff to hold an execution sale of judgment debtor’s property.


But for any sale to be completed, the sale price would have to first pay off all consensual liens and the full amount of the judgment debtor’s homestead interest ($150,000). In addition, if the judgment debtor sold the property prior to the completion of the sheriff’s sale, the judgment creditor was left without a remedy as to that property.

HB 2617
HB 2617 substantially amended prior law.

On May 19, 2021, Arizona Governor Doug Ducey signed HB 2617 into law. Effective December 31, 2021, the homestead exemption increased from$150,000 to $250,000. At first glance this may seem like a positive change for homeowners, but the new law also offers fewer protections against judgment creditors.

On and after January 1, 2022, a civil judgment will become a lien on the debtor’s homestead and attach directly to the real property after the creditor records a judgment in the county where the real property is located. The attachment will be automatic and retroactive for existing recorded judgment liens, allowing creditors a chance to pursue any past judgment debts upon a debtor’s sale or refinance of a homestead property. Debtors will no longer own their homestead “free and clear” of judgment liens.

While this new law dramatically alters debtors’ rights, it creates several new ways for creditors to collect on judgment liens.

First, creditors can look to the equity in homestead property as creditors can be paid from the proceeds of a judgment debtor’s sale of the homestead after the$250,000 exemption is paid to the judgment debtor.

Second, and more importantly, judgment creditors are also now entitled to cash proceeds from a debtor’s refinance. “If the judgment debtor receives cash proceeds from refinancing the homestead property that is subject to a judgment lien, the judgment creditor must be paid in full from those proceeds before the judgment debtor . . . receives any proceeds.”2 This prevents the judgment debtor from siphoning equity out of the homestead without selling the property.

Ultimately, the new law requires judgment creditors to be paid upon the refinance or sale of the homestead property before title to the real property may pass free and clear of any encumbrances, with certain exceptions based on the amount of proceeds expected to be paid to the judgment debtor from the sale.

For example, if after deducting from the proceeds of the sale the amount of any consensual liens and the reasonable costs of sale, the anticipated payment to the judgment debtor is less than 80 percent of the $250,000 homestead exemption (or less than $200,000), a title insurer may record a notice of partial release of judgment without prior notice to judgment creditors.

However, if the anticipated payment to the judgment debtor is at least 80 percent of the amount of the homestead exemption (i.e., $200,000 or more), the title insurer must follow specific procedures to notify the judgment creditor that the judgment lien appears reasonably likely to be extinguished. If those procedures (which include among others, mailing notice via certified mail and return receipt requested) are followed, and no objection is lodged by the judgment lienholder, the title insurer may prepare, sign and record a notice of partial release of the judgment lien, thereby extinguishing the judgment lien and allowing the property to transfer to purchasers and encumbrancers for value clear of the lien.

The notice of partial release of the judgment lien does not affect a judgment lien on any other real property owned by the judgment debtor apart from the homestead property identified in the notice of partial release of judgment lien.

Finally, a title insurer that prepares or records a notice of partial release of the judgment lien is liable to any party for the actual damages, including attorneys’ fees and court costs, that are caused by wrongfully recording any notice of partial release of the judgment lien.

CONCLUSION
It is important that judgment creditors understand their new rights pursuant to HB 2617 given that the law in this area has remained largely unchanged for several decades.

With rising home prices throughout Arizona, some homeowners have suddenly found themselves with significant new equity in their homes, which as of the end of 2021, could be subject to collection by judgment creditors upon a sale or refinance by the debtor.

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