Are Mortgages Recourse Loans? It Depends on Your State
Uncover how state laws define a mortgage's liability, determining your financial exposure beyond the property. Understand this crucial distinction.
Mortgages are the primary means for many to acquire property. A key aspect of these loans is whether they are “recourse” loans. This distinction determines a borrower’s financial liability beyond the collateralized property. The nature of a mortgage—whether recourse or non-recourse—depends on the laws of the state where the property is located. Understanding this difference is important for homeowners, as it directly impacts their financial exposure in the event of a default or foreclosure.
Understanding Recourse and Non-Recourse Loans
A recourse loan allows the lender to pursue the borrower for any outstanding debt even after the collateral securing the loan has been seized and sold. If the sale of the collateral does not fully cover the loan amount, the lender can recover the remaining balance from the borrower’s other assets. For example, a car loan or a personal loan is recourse, allowing the lender to seek repayment from the borrower’s wages or bank accounts if the collateral’s sale is insufficient.
In contrast, a non-recourse loan limits the lender’s recovery solely to the collateral specified in the loan agreement. If a borrower defaults, the lender can only foreclose on the collateral and cannot pursue further legal action to collect any remaining money owed. The difference lies in the borrower’s personal asset risk: with a recourse loan, personal assets are exposed, while with a non-recourse loan, they are protected from further claims by the lender. Non-recourse loans often carry higher interest rates or stricter terms due to the increased risk for the lender.
State Laws Governing Mortgage Recourse
Whether a mortgage is recourse or non-recourse depends on state law. Many mortgages are recourse by default, but various states have enacted “anti-deficiency statutes” that limit or prohibit lenders from seeking a “deficiency judgment” after a foreclosure. A deficiency judgment is the difference between the outstanding loan balance and the price at which the foreclosed property is sold.
States vary in their approach to these laws. Some states offer anti-deficiency protections, often for purchase-money mortgages on owner-occupied primary residences. Other states may permit deficiency judgments under specific conditions, such as after judicial foreclosures, or for second mortgages or investment properties.
The type of foreclosure process, whether judicial or non-judicial, also influences a lender’s ability to obtain a deficiency judgment. Judicial foreclosures involve court proceedings and allow lenders to seek a deficiency judgment as part of the lawsuit, though some states require a separate action. Non-judicial foreclosures, which occur outside of court, are faster and less expensive for lenders but restrict their ability to pursue a deficiency judgment. Even where permitted, a lender may choose not to pursue a deficiency judgment due to associated costs or the borrower’s limited ability to repay.
Consequences of Mortgage Recourse
When a mortgage is recourse and a lender pursues a deficiency judgment, the implications for the borrower are substantial. After a property is sold through foreclosure for less than the outstanding mortgage balance, the lender can seek a court order for the remaining debt. This judgment can lead to various collection actions against the borrower’s other assets.
Lenders may employ measures such as wage garnishment, where a portion of the borrower’s earnings is withheld to satisfy the debt. Bank accounts can be levied, allowing the lender to seize funds directly. Liens can also be placed on other properties or assets the borrower owns, complicating future financial transactions. A deficiency judgment impacts a borrower’s credit history, remaining on credit reports for several years and affecting the ability to secure future loans or credit.
Debt forgiveness, such as that resulting from a short sale or foreclosure where a deficiency is cancelled, can have tax implications. If a lender cancels debt, the forgiven amount is considered taxable income to the borrower unless an exception applies. The qualified principal residence indebtedness exclusion allows taxpayers to exclude forgiven mortgage debt on their primary residence from their taxable income through the end of 2025. This exclusion is capped at $750,000 for single filers and $375,000 for married individuals filing separately. Borrowers receive a Form 1099-C from their lender reporting the cancelled debt.