Most homeowners assume all types of mortgages have similar terms and conditions. They don’t, and when the housing bubble burst in the late 2000’s, many learned a hard lesson. There is a huge difference between non-recourse loans and recourse loans. While the terminology is strange, the difference is an important one worth taking the time to understand.
Why You Want a Non-Recourse Loan
You know when you get a mortgage or a car loan, that the house or car act as collateral for the loan. This means if you as the borrower default on payments, the lender can seize the collateral tied to the loan.
The protection a non-recourse loan provides is that even if the house does not cover the full value of the defaulted loan, that is all the lender can take. If the house doesn’t sell for what is owed on the loan, the lender has to absorb the difference and walk away.
That’s why borrowers always want non-recourse loans, while lenders almost always favor recourse loans.
What Can Happen With a Recourse Loan
With a recourse loan, the lender is allowed to seize your home if you default on your loan payments. The difference is with a recourse mortgage, if the sale of the house doesn’t cover the loan, the lender can go after other assets or sue to have your wages garnished.
Legal Implications When You Default on a Loan
Whether your mortgage is a recourse or non-recourse loan, varies from state to state, depending on state law. With a recourse loan, the bank generally cannot take further legal action to collect, in effect cancelling the debt.
When banks cancel a debt, they will issue a Form 1099-C. They will indicate on the form if the borrower was personally liable (recourse) for repaying the debt, or not (non-recourse). There are tax implications too complicated to include here but a good starting point is the IRS website, Lesson on Cancellation of Debt Basics.