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Is My HELOC a Recourse or Non-Recourse Loan in California?
Monday, Sep 21, 2009
Question: In 2005, I bought my house in California. I have two mortgages 80/20. First one (80% = $335,200) with Aurora loan services provided by Freddie Mac AND the second loan (20%= $83,800) which is called HELOC from Wells Fargo. I have not done any refinancing or modification to either and was regular in payments until January 2009 and started falling behind in my payments. I am working with the first mortgage for a short sale of my home. My concerns are, will the lenders chase me after a short sale process or in worst case after foreclosure? Are these non-recourse loans? Also, I heard about the "Mortgage Forgiveness Debt Relief Act," which is applicable till 2012. What if the foreclosure happens this year and bank couldn't sell the house until 2012? Does the "Mortgage Forgiveness Debt Relief Act" help me? Or does this rule look at the date which the actual foreclosure happened (not the date which the bank was able to resell the property?
Answer: I see three major issues in your question.Foreclosure, generally
When a mortgage lender forecloses on a home, the lender will generally sell the property, either at auction or by offering the property through a broker. Once the home is sold, the lender applies the sale proceeds to the balance of the original mortgage. If the sale proceeds are insufficient to cover the entire amount owed, which is often the case, especially with the recent drop in home prices, the remaining debt becomes a "deficiency balance." Depending on the type of loan and the laws of the state in which the property is located, the lender may be able to pursue the borrower for payment of the remaining balance of the debt.
Recourse vs. Non-recourse Loans in California
A recourse loan is one where the lender has the legal means to collect the deficiency balance from the borrower. A non-recourse loan is a loan that the creditor can only look to their secured interest. In other words, the bank can only foreclose, and cannot get a deficiency judgment and attempt to collect it from the borrower. Whether a loan is recourse or non-recourse varies with the state you reside in, and the nature of the loan.
California recourse rules are intricate and somewhat tricky. (We cite California statutes and case law here as an aid for your attorney to research your issues and facts.) Under California law, a lender cannot pursue a borrower for a deficiency balance resulting from a first mortgage used to purchase a primary residence. (Cal. Code Civ. Proc. § 580b )
In California, purchase money loans made on your home (note: not second home or investment properties) are non-recourse. (Roseleaf Corp. v. Chierighino , 59 Cal. 2d 35, 41 (1963) and Sprangler v. Memel , 7 Cal. 3d 603, 610, and 612 (1972).) 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. If the borrower never refinanced and the property is still encumbered by the original purchase money deed, the antideficiency protection remains. (Foothill Village Homeowners Ass'n v. Bishop , 68 Cal. App. 4th 1364, 1367 n.1 (1999).)
Second mortgages may or may not be recourse loans under California law. If the second mortgage was taken
out at the time of sale and was used as purchase money loan then it is a non-recourse loan. However, if the second mortgage was financed after the initial purchase of the property and is on a second deed, then Section 580b does not apply. Similarly, Section 580b also does not apply when the borrower has refinanced the property to take out additional equity or obtain financing at better terms. (Union Bank v. Wendland , 54 Cal. App. 3d 393, 400 (1976).)
California Recourse & Non-recourse HELOC Loans
A Home Equity Line of Credit (HELOC) is akin to a credit card secured by property. No money changes hands until the consumer draws on the HELOC, which is customarily not done at the moment of purchase.
By contrast, a Home Equity Loan is a lump sum borrowed at the time of purchase or thereafter and is similar to a second mortgage. How an agent/broker structures the home equity loan may determine whether a home equity loan is a recourse loan.
Many banks limit the size of mortgage loans they will extend to 80% of the appraised value of the home being purchased. Traditionally, the remaining 20% of the purchase price was covered by the borrower's down payment.
During the housing boom of the mid-2000s, people who had little or no money to bring to the table as a down payment were able to purchase homes through various creative financing arrangements. To sell a home to an individual with no money for a down payment, a broker would often arrange with the seller to formally transfer the home to the buyer for 80% of its appraised value. A separate agreement would then be made between the buyer and the seller for the buyer to pay the remaining 20% immediately following the transfer of the property. The broker would pre-arrange a home equity loan for the 20% unencumbered equity (since the home was sold for 80% of the actual value, the new owner now had 20% equity); once the property was formally transferred, the 20% home equity loan could be finalized, with the proceeds used to pay off the 20% of the value that the buyer (now the owner) still owed to the seller.
All of these transactions took place in immediate succession, so to the buyer and the seller, it looked like a single deal. However, from a legal perspective, the home equity loan closed after the sale of the property was final (since the home had already been transferred to the buyer), which could make the home equity loan a recourse loan under California law.
I do not know how your financing was arranged. I provided the scenario above as an example of how complicated home financing can be and how a home equity loan, even one signed at the same closing as the first mortgage and sale documents, may be a recourse loan.
Here, you may or may not be liable for a deficiency balance on the 80% first-mortgage loan depending on whether it is the purchase
California Recourse & Non-recourse HELOC Loans
A Home Equity Line of Credit (HELOC) is akin to a credit card secured by property. No money changes hands until the consumer draws on the HELOC, which is customarily not done at the moment of purchase.
By contrast, a Home Equity Loan is a lump sum borrowed at the time of purchase or thereafter and is similar to a second mortgage. How an agent/broker structures the home equity loan may determine whether a home equity loan is a recourse loan.
Many banks limit the size of mortgage loans they will extend to 80% of the appraised value of the home being purchased. Traditionally, the remaining 20% of the purchase price was covered by the borrower's down payment.
During the housing boom of the mid-2000s, people who had little or no money to bring to the table as a down payment were able to purchase homes through various creative financing arrangements. To sell a home to an individual with no money for a down payment, a broker would often arrange with the seller to formally transfer the home to the buyer for 80% of its appraised value. A separate agreement would then be made between the buyer and the seller for the buyer to pay the remaining 20% immediately following the transfer of the property. The broker would pre-arrange a home equity loan for the 20% unencumbered equity (since the home was sold for 80% of the actual value, the new owner now had 20% equity); once the property was formally transferred, the 20% home equity loan could be finalized, with the proceeds used to pay off the 20% of the value that the buyer (now the owner) still owed to the seller.
All of these transactions took place in immediate succession, so to the buyer and the seller, it looked like a single deal. However, from a legal perspective, the home equity loan closed after the sale of the property was final (since the home had already been transferred to the buyer), which could make the home equity loan a recourse loan under California law.
I do not know how your financing was arranged. I provided the scenario above as an example of how complicated home financing can be and how a home equity loan, even one signed at the same closing as the first mortgage and sale documents, may be a recourse loan.
Here, you may or may not be liable for a deficiency balance on the 80% first-mortgage loan depending on whether it is the purchase
money loan you used when buying the property. Regarding your 20% second mortgage HELOC, the same analysis applies. Review your loan documents carefully to determine when the loans were taken out, and how the deed or deeds read for each of the loans. I urge you consult with a California attorney experienced in property law to review your loan documents, deeds, and titles on the property.
In many cases, home equity lenders are considered "junior encumbrances" to the first mortgage, and are entitled to a portion of the sale proceeds only after the first mortgage holder collects 100% of the amount it is owed. Therefore, many people end up owing large deficiency balances on their home equity and second mortgage loans.
Mortgage Forgiveness Debt Relief Act
Under federal law, a lender must report to the IRS any forgiveness of a debt in an amount larger than $600. Borrowers are required to report this amount on form 1099C when they file their income taxes. The Mortgage Forgiveness Debt Relief Act exempts borrowers from the tax liability that would otherwise be created by a lender forgiving a portion of their loan balance, either in a short sale, loan modification, or as the result of a foreclosure. This legislation does not prevent your home equity lender from pursuing you for payment of a deficiency balance, if the lender chooses to try to collect the debt.
According to the IRS, the benefits of Mortgage Forgiveness Debt Relief Act can be used for debts forgiven in tax years 2007 through 2012.
In answer to your question, I believe you could still benefit from this law if your home is not sold until 2012. The date of the forgiveness really has little to do with the date of foreclosure; it is the date on which the lender actually forgave the debt. If you negotiate a short sale, it would likely be the date that the sale is finalized. In a foreclosure, the date of forgiveness could really be any date after the foreclosure, as the creditor can choose to forgive the debt at any time, if it decides to do so.
Any amount forgiven outside of the period covered by the "Relief Act" may be taxable as regular income. If one of your lenders forgives a debt, you should receive a form 1099C from the lender, which would show the amount and the date of the debt cancellation.
I encourage you to consult with a qualified tax professional if you receive a 1099C so that you can make sure you are correctly calculating what you owe and to ensure that you are taking advantage of all exemptions available to you. The IRS offers valuable information about the Mortgage Forgiveness Debt Relief Act .
To learn more about foreclosure, I invite you to visit the Bills.com foreclosure page . I wish you the best of luck in resolving the difficulties you are having with you home loans, and hope that the information I have provided helps you Find. Learn. Save.
Best,
Bill
www.bills.com/blog/
In many cases, home equity lenders are considered "junior encumbrances" to the first mortgage, and are entitled to a portion of the sale proceeds only after the first mortgage holder collects 100% of the amount it is owed. Therefore, many people end up owing large deficiency balances on their home equity and second mortgage loans.
Mortgage Forgiveness Debt Relief Act
Under federal law, a lender must report to the IRS any forgiveness of a debt in an amount larger than $600. Borrowers are required to report this amount on form 1099C when they file their income taxes. The Mortgage Forgiveness Debt Relief Act exempts borrowers from the tax liability that would otherwise be created by a lender forgiving a portion of their loan balance, either in a short sale, loan modification, or as the result of a foreclosure. This legislation does not prevent your home equity lender from pursuing you for payment of a deficiency balance, if the lender chooses to try to collect the debt.
According to the IRS, the benefits of Mortgage Forgiveness Debt Relief Act can be used for debts forgiven in tax years 2007 through 2012.
In answer to your question, I believe you could still benefit from this law if your home is not sold until 2012. The date of the forgiveness really has little to do with the date of foreclosure; it is the date on which the lender actually forgave the debt. If you negotiate a short sale, it would likely be the date that the sale is finalized. In a foreclosure, the date of forgiveness could really be any date after the foreclosure, as the creditor can choose to forgive the debt at any time, if it decides to do so.
Any amount forgiven outside of the period covered by the "Relief Act" may be taxable as regular income. If one of your lenders forgives a debt, you should receive a form 1099C from the lender, which would show the amount and the date of the debt cancellation.
I encourage you to consult with a qualified tax professional if you receive a 1099C so that you can make sure you are correctly calculating what you owe and to ensure that you are taking advantage of all exemptions available to you. The IRS offers valuable information about the Mortgage Forgiveness Debt Relief Act .
To learn more about foreclosure, I invite you to visit the Bills.com foreclosure page . I wish you the best of luck in resolving the difficulties you are having with you home loans, and hope that the information I have provided helps you Find. Learn. Save.
Best,
Bill
www.bills.com/blog/
Also, make sure to get a free financial health check-up with Bills IQ!
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1. Posted by Anita on Friday 25th September 2009 11:04
2 scenarios if you can help me confirm: 1- Bought a house for 600k. Loan 1 $400k, loan 2 $200k. Never refinanced. Home went into foreclosure. Both the loans are considered non-recourse right? 2- Bought a house for $300k, 1 Loan only for $300k. Couple years later, refinanced and took cash out. New loan is now $330k. Still 1 loan only. Home went into foreclosure, would this be considered a non recourse loan since there's only 1 loan ? Thank you.
2. Posted by Bill on Friday 25th September 2009 14:50
Can't answer for certain. In which state are the properties?
3. Posted by Anita on Friday 25th September 2009 16:00
Oops! Both located in CA. Thanks for your help.
4. Posted by Bill on Friday 25th September 2009 17:09
I recommend you reread the section "Recourse vs. Non-recourse Loans in California" in the article above to get a better understanding of the issue. Now let us look at your two scenarios: 1) The first and second mortgages may be non-recourse loans. Again, the California rules are tricky and I recommend you walk through the article above to see if both mortgages are a) "purchase money" loans, b) for a primary residence, c) not refinanced. 2) The mortgage in this scenario is almost certainly a recourse loan because it was refinanced. I recommend you consult with a California attorney experienced in property law issues, who can review all of your loan documents in person, and thus render a better opinion than my armchair analysis.
5. Posted by Dave on Monday 5th October 2009 10:01
Help request; I bought in 89 for 173,500, a few re-fis and 20 years later I have a !st for 495000, its now worth 300,00. I re-fied but have only the current single loan (1st), do they have "Recourse" for any remaining balance?
6. Posted by Bill on Monday 5th October 2009 17:27
Can't answer for certain. In which state is the property in question? If the property is in California, reread the section "Recourse vs. Non-recourse Loans in California" in the article above to get a better understanding of the issue.
7. Posted by Joanne on Wednesday 7th October 2009 14:52
Borrower has 1st & 2nd (non purchase $), he defaults on both, files chapter 7, says he plans to keep property and intends to make payments to both 1st & 2nd. Credit report shows 2nd as a charge-off, doesn't attempt to forclose (no value left), does he have to payoff 2nd to get reconveyance? If he modifies first under HAMP, does the 2nd get addressed under 2MP?
8. Posted by Bill on Thursday 8th October 2009 10:29
HAMP covers first mortgages/deeds of trust. It is unlikely a holder of the first mortgage is going to allow what is in effect a refinance that includes a second mortgage. That is not the intention of HAMP. Regarding the rest of your question, obviously, I don't know the entire situation here. I am unclear if the Chapter 7 in this situation discharges the second deed of trust. It would also be interesting to know if there is an SOL issue with the second deed of trust. Here's a thought -- offer the second deed of trust holder a lump-sum settlement of 5-10 cents on the dollar as a settlement agreement and release. That removes the second as an issue, cleans up the debtor's credit report, and creates a more favorable debt-to-income ratio for the debtor.
9. Posted by nicholas bajoghli on Thursday 15th October 2009 11:02
I am a broker here in san diego I am almost done with a short sale, my client bought the house for 1.8 million, a first of 1.4 million and second of 400k, both loans are purchase money, however the the set off closing documents the second is settled for 3000 but including the language that they will pursue the remaining 397 k as deficiency can they do that does this language turn the remainder into a recourse loan or is this a non-recourse loan by nature and can not be altered, the second has provided a letter saying the will settle for 3k , but it does not have a place for the borrower to sign it is just a template I don't want my client to be responsible for this deficiency
10. Posted by Bill on Thursday 15th October 2009 17:00
I am confused by the sequence of events and some of the facts in your question. I think what you are saying is that at some point in the past, your client purchased the house with a $1.4 million first deed of trust and a $400k second. Your client is now selling the property for a price less than $1.8 million in a short sale. It is my understanding that by definition, a short sale stipulates that the creditor will not pursue the borrower for the deficiency balance. I think the central issue in your question is "Can a borrower waive California's non-recourse rules?" It certainly appears that the creditor hopes it can make your client waive his or her non-recourse rights, if I am understanding your question correctly. This sounds like a bad deal, but I hasten to add that I may not be understanding your question or the facts correctly. I urge you to take these sale documents to an attorney experienced in property or bankruptcy law.
11. Posted by Sheila on Sunday 1st November 2009 15:38
Does participation in the HAMP or a Refinance under the Obama Plan turn a non-recourse California purchase loan into a recourse loan?
12. Posted by johnJ on Sunday 1st November 2009 17:25
I purchased my home in CA in 1999 for $330K. I then refinanced in 2001 and pulled money out for upgrading the home - new home loan $480K. In 2003, I refinanced again for a better interest rate (non adjustable). In 2006, I opened a home equity line of credit to upgrade again (build a pool, etc). My home equity line of credit is now at $248K. Total loans on home are totay about $718K. I am in good standing after loan modification with the first but cannot afford to pay home equity line of credit. If they foreclose (and the first consents) but the property doesn't sell for the full amount owed to both, can they pursue me personally with a judgement on future earning for the balance that will remain?
13. Posted by Bill on Monday 2nd November 2009 09:07
Sheila, as stated in my answer above, refinancing a purchase-money loan on a primary residence converts the loan to a recourse loan in California. (Other states have different rules.) However, if the borrower and lender renegotiate the terms of a purchase money loan for a primary residence in California, the alteration of the terms between the original parties does not change the loan to a non-recourse loan. Take care that in practice the renegotiated loan is really that and not a refinanced loan.
14. Posted by Bill on Monday 2nd November 2009 09:17
Johnj, under the circumstances you described under California law, your home loans are recourse loans, which means that if you default the creditor has the legal right to collect the balance remaining on the loan from you personally. This is an unsecured debt, which is like other consumer debt such as credit card or medical debt. See Collections Advice to see creditor's and debtor's rights regarding unsecured debt.
15. Posted by Jeff Allen on Tuesday 10th November 2009 11:24
I purchased my home in California in 1975 for $38,000. Over the years I have refinanced 3-4 times each time taking out money. the lender has changed a few times also over the years. Mostly the funds were used for personal use, cars etc. Some was used to upgrade the property. The lender is now Bof A with a first of $365,000. The condo at one time worth $600,000 but is now worth about $350,000. I`am in my 4th month of non-payment. I have some contact with them but so far there has been no presure from them and not much response. I also have a HELOC for $265,000 which I started 7-8 Years ago and have continued to tap into. I have continued to pay on this loan(which is also with BofA,since the rate, currently at 3% is manageable, but eventually it will probably be going up. If BofA forcloses I will try to keep paying on the HELOC but obviously Im way upside down on the property. Is the HELOC (I assume) a recourse loan? If the lender forcloses and I keep paying on the HELOC will that just become a personal loan? If I stop paying on the HELOC before the forclosure what would they probably do? I`am 62 years old, maybe the best option unfortunately should be to file Bankruptacy.
16. Posted by Bill on Tuesday 10th November 2009 12:13
I recommend you reread the section "Recourse vs. Non-recourse Loans in California" in the article above to get a better understanding of the issue. Walk through the article to see if your first deed of trust and HELOC are a) "purchase money" loans, b) for a primary residence, c) not refinanced.
If I understand your message correctly, neither loans are purchase money loans. Therefore, both are recourse loans under California law, which means that if you default the creditor has the legal right to collect the balance remaining on the loans from you personally. This is unsecured debt, which is like other consumer debt such as credit card or medical debt. See Collections Advice to see creditor's and debtor's rights regarding unsecured debt.
17. Posted by Michelle on Sunday 15th November 2009 07:45
This is a really helpful article - thank you. I have an 80/20 loan in CA that was 100% purchase money. However the second is structured as a HELOC, although I have never drawn from the account or refinanced in any way. Can you clarify how I can determine if the 2nd is non-recourse. You mentioned looking at the trust deeds. They are filed on the same day but are 2 separate documents. I don't see though how that could change the fact that it was still purchase money that without I could not have acquired the property. Any help here would be great. Thanks!
18. Posted by Bill on Monday 16th November 2009 13:33
I understand your frustration with the explanation in the article above. Unfortunately, the crucial details that determine whether a HELOC on a California deed of trust is recourse or non-recourse are evident only when examining the transaction. If the first deed of trust (the first "mortgage") and the HELOC occurred as a single transaction, then you and I would argue to a court that both are subject to the antideficiency statute. You may argue that the HELOC should be seen as a "second mortgage" with slightly unconventional repayment terms. Regardless of what you and I agree to, I urge you to consult with a California attorney who has experience in property law. An hour's worth of attorney's time is not cheap, but the advice you get will be more precise because he or she will be able to review all of the documents surrounding your home purchase in person.
19. Posted by Bernie Paramo on Thursday 19th November 2009 13:41
In CA. Short sale of my condo. Purchased in 2005 for $310K. One loan for $217, second loan for $93K. Refinanced my second through BofA for a better rate and cash out of $10K which I used to remodel. Total HELOC of $103K (the $93K went straight to the second loan). My understanding is that when I refinanced the 2nd 580b no longer applies and I am personally liable for the entire HELOC? One other comment, BofA had me lie about my income to qualify me for this HELOC, do I have any legal recourse on this? I know I could have said no but when they dangled a 5% interest rate instead of the 9% I had on the second it was tough to be that ethical....Thanks for all your help!
20. Posted by Bill on Thursday 19th November 2009 16:00
In my opinion, whether a HELOC is subject to California's antideficiency rules is dependent on the particular details surrounding the purchase of the property. In my opinion, if the first deed of trust and the deed of trust for the HELOC are created simultaneously, then I argue that both are purchase money loans and therefore subject to the antideficiency rules. However, I hasten to add that my observation is not legal advice. Here, you refinanced the second deed of trust, which made it a recourse loan regardless of its original pedigree. If you default on the second deed of trust/HELOC, the creditor has the legal right to foreclose on the property. If the value of the property is the same or less than the balance of the first deed of trust, the HELOC creditor can hold you personally liable for balance. This is an unsecured debt, and is treated the same as other unsecured debt such as credit card debt, medical bills, and so on. Regarding your question about BofA dangling a 5% rate in front of you as an inducement to make a false statement on your mortgage application, I urge to you consult with a California attorney experienced in consumer law. See National Association of Consumer Advocates to find one in your area. Ask the attorney if you have a cause of action under federal or California predatory lending laws.