Recourse vs. Non-Recourse Loans
I’ve had several questions from clients regarding short sales, foreclosures and bankruptcy and how it will affect them. It can be overwhelming and tough to know who to actually talk with about a looming financial crises. I hope this short explanation on recourse vs. non-recourse loans will shed some light on the different types of loans we may have on our properties and the resulting exposure we have.
Don’t Make the California Refinance Mistake.
Central to the mortgage bailout plan is the refinance of adjustable rate mortgages to fixed rate mortgages. There is even a plan to nearly double the “conforming” loan limit to help jumbo mortgages refinance. But before you jump in, make sure you are not making the California Refinance mistake. California homeowners have been making the “refinance mistake” as long as the bubble has been going on. The big mistake homeowners make is turning a ”non-recourse” second loan into a “recourse” loan by refinancing it. A non-recourse loan is a loan that the bank can only look to their secured interest. In other words, they can only foreclose, they cannot get a deficiency judgment and chase you into bankruptcy collecting it. THIS IS HUGE! You can walk away from a non-recourse loan. So how is a second mortgage a non-recourse loan? Simple, it was “purchase money” for your home. A purchase money loan is one where the money went from the lender, to escrow, and then to the seller or to pay purchase closing costs. In California, purchase money loans made on your home (note: not second home or investment properties) are non-recourse. It’s simple as that.
The mistake comes when you refinance your second purchase money mortgage. Because it is no longer a “purchase money” loan a refinance transforms it into a “recourse” loan. That means the lender will chase you into bankruptcy collecting it. Or worse, they will sell it to a debt scrounger, the worst form of debt collector. Your life will be hell if it falls into their hands. It used to be second mortgages were never purchase money. Enter the housing bubble and creative Wall Street financing. The result: the 80/20 loan. It was really a beautiful thing. Buy a house with no money down, get two loans, a cheap interest rate first covering 80% of your loan, and a high rate second mortgage covering the 20% you were supposed to put down to have some skin in the game. Wall Street sold the loans to different investors and bought insurance on the second to cover the higher risk of default. But there was an unintended consequence Wall Street seems to have
overlooked. The Purchase Money Rule made these loans “non-recourse.” This has come back to bite. It turns out ETRADE has a bunch of California Second Mortgages. Guess what? They are unsecured now because housing prices have fallen so much, and there is no recourse against the borrowers. They can just walk away-AND THEY ARE.
A couple of tips:
1. You can refinance your first mortgage or both mortgages into one mortgage and still be “non-recourse.” This is because the One Action Rule prevents lenders from looking beyond the mortgage in a non-judicial foreclosure. Second mortgages do not benefit from this rule because they have not had their “one action.”
2. If a seller took a second loan on your property, they cannot look beyond a foreclosure even on investment properties or second loans. This is the “Vendor Rule.”
3. Always keep economics in mind. It’s better to let your home go and walk away without liability to the bank then to try to save your home with a refinance and become personally liable.
Written by Ken Andrews