Recourse loans are loans that permit the lender to come after you in case you default on the loan. You can contrast recourse loans with non-recourse loans, which create more risk for lenders. Let’s take a look at recourse loans, how they work, and how to identify them.
Recourse Loans – The Recourse
Recourse loans get their name from the fact that lenders have the option, and are allowed to go after you for amounts that you owe – even after they™ve taken back the collateral (in the case of a mortgage, the home). If you default on a recourse loan, the lender can bring legal action against you, garnish your wages, and try to collect the amount you owe.
A legal action to collect money after foreclosure is generally called a deficiency judgment.
A non-recourse loan does not allow the lender to pursue anything other than the collateral. For example, if you default on your non-recourse home loan, the bank can only foreclose on the home. They generally cannot take further legal actions against you. The bank is out of luck even if the sale proceeds do not repay the loan.
Non-recourse loans create the most risk for lenders because they can only collect the collateral, and nothing else. As such, lenders of non-recourse loans want to see lower loan to value ratios to reduce their risk. These loans may have higher interest rates than recourse loans.
Identifying Loan Types
You should consult your attorney or tax adviser be certain whether you have a recourse loan or a non-recourse loan. However, you can use the information below for discussion.
State laws often dictate whether a loan is a recourse loan or not. California is best known as a non-recourse loan state that makes it hard for lenders to sue. Some states give lenders flexibility in how they pursue defaults, but many lenders choose not to sue because defaulting borrowers often don™t have much to sue for.
- List of Non-Recourse States – see your state’s rules on deficiency judgments.
Refinances, second mortgages, and “cash out” transactions tend to create resource loans.
Purchase loans for your primary residence are most likely non-recourse loans in non-recourse states.
Recourse Loans and Taxes
In the event of default, your tax liability will depend on whether or not you have a recourse loan. Tax consequences of recourse loans, non-recourse loans, foreclosure and short sales. **Note the Mortgage Debt Relief Act generally allows tax payers to exclude the discharge of debt on their principle residence this includes mortgage debt forgiven in connection with a short sale.
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