Information on California Recourse Loan
- 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.
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I hope this information helps you Find. Learn & Save.
Regarding the debt income issue, the federal Mortgage Forgiveness Debt Relief Act and its California counterpart apply in the situation you described.
Consult with a California lawyer who has real property experience.
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.
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.