Is My HELOC a Recourse or Non-Recourse Loan in California?

image alt text
Daniel CohenJun 30, 2015
Key Takeaways:
  • California's anti-deficiency laws are complex.
  • A HELOC may or may not be a non-recourse loan in California.
  • Consult with a California lawyer for precise advice for your facts.
My first mortgage is a non-recourse loan, but what about my HELOC? How does the Mortgage Forgiveness Debt Relief Act help me?

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?

I see three major issues in your question.

Foreclosure

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 deficiency 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 where the creditor's ability to collect on a defaulted loan is restricted to any assets used to secure the loan. In other words, if the lender forecloses, then it 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 residence. (Cal. Code Civ. Proc. § 580b)

In California, purchase money loans made on your home are non-recourse. (Roseleaf Corp. v. Chierighino, 59 Cal. 2d 35, 41 (1963) and Spangler 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 anti-deficiency 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 (Brown v. Jensen, 41 Cal.2d 193 (1953).) 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 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 1099-C 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.

MDFRA Extended

Congress has extended the Mortgage Debt Forgiveness Relief Act more than once. It expired at the end of 2014. Unless Congress renews the act again, mortgage debt that is forgiven in 2015 will be taxable income.

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 1099-C 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 1099-C, 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 hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com

Get up to 5 competing mortgage quotes

10 Comments

SSonia, Jan, 2012
I just received a 1099c from BofA for the debt forgiven on my HELOC. The HELOC was part of my original loan and from what I can see in messages throughout this page, is considered part of the original purchase loan (80/20?). My house in CA was foreclosed on in 2010 and I was told at that time by BofA that the two loans would collapse and I would receive one 1099c. That's not what happened. I received a 1099c for 2010 for the home and now I just received another for the HELOC. This 1099c shows I'm personally liable for the debt whereas the first 1099c said the opposite. Had they combined the loans as I was told, the debt I would have been responsible for would not have been as much because the mortgage company was evidently given surplus funds which created a value of my house greated than what I owed. With this 1099c of over $56k, am I going to be responsible for the taxes on this amount? I've tried talking to the bank to reissue the 1099c to say I am not personally responsible, but they feel they were doing me a favor by forgiving the loan and not coming after me for that. Thank you
BBill, Jan, 2012
Please read the Bills.com resource Mortgage Forgiveness Debt Relief Act to learn if you qualify.
DD, Feb, 2012
Hi Sonia,We are having the same issue. What have you learned since posting this question? Will we have to pay taxes on the heloc, even though it was purchase money to buy the house?
SSonia, Feb, 2012
I haven't learned anything concrete. I will be talking to my tax preparer and also a real estate attorney familiar with this issue to see what my options are. I tried to get the bank to re-issue the 1099 to say I wasn't responsible for the debt, but no such luck.
MM, Feb, 2012
BBill, Feb, 2012
Speaking with your tax preparer is smart. It is my understanding you can file and use the IRS Form 982 even if you did not get the 1099-C. It is similar to a person who works as an independent contractor and does not receive a 1099. In such a case, the contractor still declares the income and indicates to the IRS that no 1099 was received.
MMonica, Jan, 2012
Hello, Our home was just forclosed on in June 2010. Now, our Lender for the second is coming after me for the money. My husband was not on the loans, but held title on the property and is listed on both Deeds of Trust. My husband filed for bankruptcy in March 2010. His attorney let me know that I would be protected under common law in California and since my husband claimed BK, they are not able to come after me for the money. I have told our Lender this information and they continue to pursue payment. Have you heard of a spouse being protected under Common Law?
BBill, Jan, 2012
California common law does not apply in this instance, but federal bankruptcy law does. If a spouse files under chapter 7 in any state, the spouse is not protected. However, if the spouse files for chapter 13 in a community property state, he or she enjoys the same protections the filing spouse has under bankruptcy law. Therefore, my questions for you are, "What chapter of bankruptcy did your spouse file?" and "Where is your spouse's case in this process?"

Ask your spouse to consult with the bankruptcy attorney to learn more about any stay that may protect you from creditors.