A Recourse Vs. Non-Recourse Mortgage

A foreclosure may not be the end of your home loan responsibilities.
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The recourse status of a mortgage loan holds considerable importance in the event of a foreclosure or debt restructuring of a home loan. This status determines whether the bank will still have the right to pursue you personally for any unpaid amounts, generally by obtaining court approval. However, the recourse status of a loan depends on several factors, including state law.

Recourse Loans

A recourse loan contains a provision in its contract stipulating that the lender has the right to pursue a borrower for any unpaid amounts. While most borrowers prefer to have the lender waive this right, some will opt to sign a recourse mortgage because it is often cheaper and easier to obtain. Recourse loans are suitable for borrowers with a consistent and stable source of income, as well as sufficient liquidity (cash savings and investments easily convertible to cash). Still, recourse loans pose the most risk during a housing boom when house prices have a long way to fall once the bubble bursts.

Non-Recourse Loans

Unlike a recourse loan, a non-recourse loan prevents the lender from pursuing personal assets in the event of foreclosure. In this case, the only remedy for any unpaid debts is the repossession of your committed collateral. For example, in the event that you foreclose on your house, the lender can only reclaim your property, sell it during a foreclosure auction and use the sales proceeds to cover their losses. Your responsibility for the debt ends here and the lender cannot legally obligate you to pay for any remaining unpaid debts. Because non-recourse loans increase the risk for lenders, they are generally harder to get and are more expensive (higher interest rates). Borrowers can reduce the costs by increasing the down payment amount or by agreeing to a shorter loan term.

Deficiency Judgment

A deficiency judgment occurs when a borrower defaults on a loan and is unable to repay the total balance. This generally applies to recourse loans. When this happens, the lender may have the right to file for a deficiency judgment with the local court and obtain the right to pursue the borrower’s personal assets to cover losses. The right to a deficiency judgment depends on many factors including state law and whether there are additional liens. If a deficiency judgment is granted, the borrower is held responsible for any unpaid debts and can have bank accounts and wages garnished.

Tax Implications of a Non-Recourse Loan

If the lender decides to “forgive” the unpaid debt amounts, the borrower effectively receives income, according to IRS. Therefore, the borrower will have to include the amount of forgiven debt on their tax returns. However, the Mortgage Debt Relief Act of 2007 states that married taxpayers are allowed to exclude up to $2 million ($1 million if married and filing separately) of forgiven debt from income, provided that the canceled debt was due to debt restructuring or foreclosure of the taxpayer’s primary residence.

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