Why restoring access to subordinate mortgages is essential for California families, businesses, and housing goals
By Kevin Gould – President and CEO, California Bankers Association
Nov 13, 2025                                                                                                                                            
A new law embedded in a budget trailer bill makes it harder to get a second or subordinate mortgage in California. While the measure aims to address so-called “zombie” subordinate mortgages, where borrowers believe their debt has been forgiven only to face renewed collection efforts, it was poorly written and has created broad, unintended consequences.

In summary, the new law insensibly makes legal and lawful actions by lenders unlawful and places impediments on collateral recovery when borrowers stop making payments. Why is that a big deal? Because lenders will be disincentivized to make new loans because of increased risk and will hamstring efforts to help distressed borrowers avoid foreclosure.

Let’s set aside how the new law passed by the Legislature violates state and federal constitutionally protected rights of lenders and focus instead on how legislators’ actions have hurt the constituents they represent.

Consider the many ways in which subordinate mortgages matter.

Achieving the American Dream is increasingly challenging given the high cost of housing in California. Many families can’t afford a 20 percent down payment and look to a subordinate mortgage to make homeownership possible.

For families that own homes, subordinate mortgages are an important financing tool that unlocks equity to pay for home improvements, college tuition, and medical expenses. Lawmakers have made the construction of accessory dwelling units (ADUs) part of the affordable housing solution, believing that such units can partially solve for the lack of inventory in the state. Using home equity has been a common financing mechanism for the construction of ADUs. Borrowers impacted by the devastating Los Angeles wildfires in January may find themselves under-insured creating a gap between their insurance proceeds and the cost of reconstruction.

The harm caused by the Legislature doesn’t stop with consumer financing, it also extends to small business lending. Many small businesses rely on loans guaranteed by the federal Small Business Administration (SBA). For the SBA to guarantee a loan, lenders may be required to take collateral through a security interest in the residential real property of the borrower. Unfortunately, the new law applies to any “security instrument in residential real property” implicating small business loans.

The Legislature inflicted this wound and, consequently, has increased credit and compliance risk and heightened exposure to legal liability for otherwise lawful activity, all things that discourage lending.

And if the damage to new loan originations wasn’t enough, the law impacts existing mortgages and makes it challenging for mortgage servicers trying to help borrowers avoid foreclosure. During the Great Recession, mortgage servicers helped borrowers avoid foreclosure by forgiving principal to achieve a more sustainable monthly mortgage payment. When doing so, the mortgage servicer must issue an IRS form documenting the forgiven principal.

Under the newly enacted provisions, if a borrower subsequently defaults after a good faith attempt to help them avoid foreclosure, the subsequent pursuit of a foreclosure sale after the issuance of the IRS form is considered an unlawful act. We fear mortgage servicers will be discouraged from working with borrowers by reducing principal going forward.

The significant unintended consequences resulting from the Legislature’s actions were avoidable. The California Bankers Association and others involved in mortgage finance advocated for a sensible compromise that would provide meaningful consumer protections and address the identified concern, but our solution was set aside. And, instead of surgically addressing the issue of “zombie” subordinate mortgages, the Legislature has driven a stake into the heart of a vital financing tool.

When the Legislature returns from its interim recess in January, it should advance urgency legislation to correct its mistake, not because it benefits lenders, but because their constituents deserve better. If the Legislature cares about affordable housing and the important role that small businesses play in supporting our economy, they’ll make it right. We are ready to help them fix it.