Information on California Recourse Loan

UpdatedMar 18, 2008

Key Takeaways:

A purchase money loan is not a recourse loan in California.
Refinancing a purchase money loan converts the loan to a recourse loan.

What is the meaning of a "Recourse Loan"? I am a resident of California.

I have 80/20 loan when I first bought my home, 20 being HELOC. The following year I refinanced this HELOC with another HELOC, but with fixed rate. Does this mean this HELOC became a recourse loan in California?

(Note from Bill: The following is a good but brief comparison of recourse and non-recourse loans in California, and how this issue pertains to Home Equity Lines of Credit. For a more in-depth discussion of these issues, see "Is My HELOC a Recourse or Non-Recourse Loan in California?")

I think by refinancing only your second loan, you turned the loan into a recourse loan. A recourse loan is one where the lender can collect the amount you owe on a deficiency balance. 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 attempt to collect it. Whether a loan is recourse or non-recourse varies with the state you are in.

The big mistake homeowners make is when they unknowingly turn a non-recourse second loan into a recourse loan by refinancing it. So how is a second mortgage also a non-recourse loan? Simple, in an 80/20 loan, 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.

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 has the option of chasing you into bankruptcy collecting it. Or worse, they will sell it to a debt collector.

I suggest that you confirm the status of your second loan with your lender, and see if another form of refinance (to club both the loans) will make it a non-recourse loan.

For more information on mortgages, please visit our mortgage information page.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com

10 Comments

RRony, Apr, 2014

I purchased my property in December 2005 for $525,000. I financed my loan with first mortgage of $421,000 and second HELOC for $79,000. I never refinanced my loan. I short sold my home last year for $336,000. Bank issued a 1099-C to me. Is this a recourse loan?

BBill, Apr, 2014

In California, the general rule is if a home loan is a purchase-money loan, it is a no-recourse loan. No-recourse means the lender has no legal means to compel the borrower to pay any deficiency balance should there be a foreclosure.

But what about short sales? Calif. CCP 580(e) prohibits a deficiency judgment on a note secured solely by a deed of trust or mortgage for a dwelling of not more than four units when the property is sold for less than the balance of the note. You cannot waive this rule in a short sale contract.

I can't give you legal advice, as only an attorney can properly do so. However, my non-legal opinion, based only on the information you shared, is that your loans are no-recourse.

jjon, Jun, 2012

I have a 1st time buyer 30 year fixed fha loan in California, never refinanced. Is this loan recourse or non-recourse?Thanks

BBill, Jun, 2012

Here's the test in California: Was the loan a purchase money loan? If yes, then the loan is covered by California's anti-deficiency law. A purchase money loan is one used to purchase the property. If you used the loan you described to purchase the property, then it is a purchase money loan, and therefore is covered by California's anti-deficiency law.

QQuinn, Mar, 2012

Dear Bill,I had my interest rates lowered on my first loan of $455,000 from 6.5% to 3. 75% two years ago even though I had no equity in the house. I left my second alone($160,000) and did not refinance that loan. I contacted the lenders of my first loan and they said that it transformed into a recourse loan (as in a refinance). I am looking at short selling the house in California since my once $610,000 house is now worth $410,000. Will I owe the bank the difference between the purchasing and selling prices of the property on the first loan that is now recourse? What about the IRS? This is my first house and I have no money down and I have been paying interest only. Thank you, Quinn

BBill, Mar, 2012

California' s anti-deficiency / no-recourse laws are tricky. If you refinance a California purchase-money home loan you remove the anti-deficiency protections for purchase money loans in a foreclosure. However, California's legislature created a nice exception for homeowners who agree to short sale their homes. This is found in California CCP 580e. If a California homeowner short-sells their home, they do not have liability for any deficiency balance.

Regarding the debt income issue, the federal Mortgage Forgiveness Debt Relief Act and its California counterpart apply in the situation you described.

llarry, Oct, 2011

i own a home in california. i stripped the second with a chapter 13 bankruptcy. in the event of foreclosure or shortsale, will the line of credit turn the nonrecouse into a recourse loan.

BBill, Oct, 2011

The facts you shared confuse me, and as a result I am unable to answer your question. If the "second" you mentioned is the exact same loan as the "line of credit," then you have no personal liability for this loan because, as you said, it was stripped in a Ninth Circuit Court chapter 13. (Other circuit courts may not allow a chapter 13 to strip a junior loan.) If the "line of credit" you mentioned is a separate loan, and if it was purchase money loan that was never refinanced, then it is a non-recourse loan. If the "line of credit" was not a purchase money loan, then you have personal liability for this loan.

Consult with a California lawyer who has real property experience.

KKay, Oct, 2011

Hi Bill, I hope you can help answer my question... I am current on my first home which is underwater, and have just been approved for a new home loan (without needing the rental income agreement for my first home. What could happen if I shortsale or foreclose on my first home after I buy my second home?I love my first home and thought about renting it out, but my fair is that in about 5 years my monthly mortgage will convert into principle and interest at a high interest rate and I would no longer be able to keep the house then, and I heard that the Debt Forgiveness program where you may not not have to pay taxes on your Shortsale/Foreclosed home is to expired end of 2012... Any advice or suggestions will help. Thanks.

BBill, Oct, 2011

It is true that the Mortgage Forgiveness Debt Relief Act (MFDRA) will expire at the end of the 2012, if Congress does not extend it.

As the law currently stands, if your short sale takes place after 2012, you will be required to declare as income the amount of debt that your lender forgives. There is still one way out, potentially. If you meet the IRS' definition of hardship, you can use the IRS Form 982, to avoid paying taxes on the forgiven debt.

The MFDRA only applies to one's principal residence, whereas a taxpayer who meets the hardship test of the Form 982 can avoid the taxes on any forgiven debt.

I suggest that you consult with a tax professional, to see if you can use the Form 982. Keep in mind that if you refinance your current loan, it will become a non-recourse loan, it is currently a recourse loan. Potentially being responsible for the deficiency balance is something you should consider as well. If your current loan is a non-recourse loan, before you finalize your refinance, you need to think long and hard about such factors as: how far underwater you are on the home; how likely your lender would be to try to aggressively collect on the deficiency balance; and whether you could file bankruptcy and discharge the deficiency balance.