Is Credit Card Debt Recourse or Nonrecourse?

When a borrower defaults, the type of debt they hold dictates the lender’s next steps. The distinction between recourse and nonrecourse debt determines the extent to which a lender can pursue a borrower’s personal finances to recover a loss. This framework is important for analyzing how specific obligations, such as credit card debt, are treated in the event of non-payment.

Understanding Recourse and Nonrecourse Debt

Debt is broadly categorized into two types: recourse and nonrecourse. A recourse debt holds the borrower personally liable for the full amount of the loan. If a borrower defaults on a recourse loan, the lender can seize and sell any collateral. Should the sale fail to cover the outstanding balance, the lender has the right to pursue the borrower’s other personal assets, such as bank accounts or wages, to make up the difference. This structure places more risk on the borrower.

Conversely, a nonrecourse debt limits the lender’s claim to only the collateral securing the loan. If the borrower defaults, the lender can take possession of the specified asset, but their ability to collect stops there, even if the asset’s value is less than the remaining loan balance. For example, with a nonrecourse mortgage, the lender can foreclose on the house but cannot typically seek further payment from the borrower’s other funds. This arrangement shifts more risk to the lender, which is often reflected in higher interest rates or stricter qualification requirements.

The Classification of Credit Card Debt

Standard credit card debt is classified as recourse debt because it is a form of unsecured debt. Unlike a mortgage or an auto loan, there is no specific asset, or collateral, that a credit card company can seize if a cardholder stops making payments. Because there is no property to repossess, the lender’s only path to recovery is to pursue the borrower’s personal assets.

The agreement signed by the cardholder makes them personally liable for the full balance owed. Even in the case of a secured credit card, where the borrower provides an initial security deposit, the underlying debt is typically still recourse. If the outstanding balance exceeds the amount of the deposit, the creditor can pursue the cardholder for the remaining difference, just as they would with a traditional unsecured card.

Creditor Actions for Defaulted Credit Card Debt

When a credit card account goes into default, the recourse nature of the debt allows the creditor to take several actions to collect the amount owed. Initially, these efforts involve collection attempts, such as phone calls and letters. If these methods fail, the creditor may sell the debt to a collection agency or file a lawsuit against the borrower to compel payment. A lawsuit can lead to a court judgment in the creditor’s favor, especially if the borrower does not respond to the court summons.

Once a judgment is obtained, the creditor gains access to legal collection tools. They can seek a court order for wage garnishment, which requires the borrower’s employer to withhold a portion of their paycheck—often up to 25% of disposable income—and send it to the creditor. Another action is a bank account levy, where the creditor can withdraw funds directly from the borrower’s checking or savings accounts. A creditor with a judgment can also place a lien on the borrower’s property, such as a home, which must be paid before the property can be sold or refinanced.

Tax Implications of Forgiven Debt

When a creditor ceases collection efforts and forgives or cancels a portion of the debt, such as after a settlement, there can be tax implications. The Internal Revenue Service (IRS) may view this event as Cancellation of Debt (COD) income, meaning the forgiven money is treated as taxable income to the debtor.

If a creditor forgives a debt of $600 or more, they are generally required to file Form 1099-C, Cancellation of Debt, with the IRS and send a copy to the borrower. The amount shown on this form is reported as “other income” on the individual’s tax return, such as on Schedule 1 of Form 1040. This means the borrower may owe taxes on the money they did not have to repay.