Deficiency Judgement

To the current homeowners: think again before you send the keys to the bank and walk away from the house. Do you think that when the housing prices fall, you can simply walk away from all the loans? Well, if you didn’t know, I am going to explain it to you. There are loans that you can walk away, and there are loans that you cannot. It’s called a recourse or a non-recourse loan.

A non-recourse loan means that there is no other recourse available to the lenders besides taking back the home. A typical non-recourse loan is a home loan for purchase. If the house falls below the balance of the purchase loan, the buyer can walk away from the house without any serious consequences (maybe except a big blemish on the credit report). On the other hand, a recourse loan means that the homeowner is personally liable for any “deficiency” when the lenders cannot recover the loan amount by selling off the house. A typical recourse loan is a home equity loan or a line of credit from home equity. As far as I could research, I don’t think a refinanced home loan is definitely a recourse loan. But I’m almost certain that a cash-out refinanced loan is recourse loan. As far as the legal language is concerned, a refinanced loan obviously is not a loan made for purchase.

So if you think that banks are so stupid of lending you a first loan of 80% LTV (Loan to Value), and piggy-back another 15% or even 20% through home equity loan, then you’re mistaken. On the first loan, the banks have a 20% cushion protection before they are not able to sell the house to recover the loan. On the other home equity loans, banks have the option of going after you in court even if after the sale, they cannot recover those loan amount. Legally speaking, you would have fare better if you took out a loan beyond 80% LTV, and pay PMI (private mortgage insurance) on the non-recourse purchase loan. The same is true for refinancing. If you have refinanced your purchase loan in the past, most likely you have just given up the ability of walking away from your home free & clear. I don’t know how adjustable rate mortgage (ARM) purchase loans are treated. But if you faked your income/asset numbers on the application, it would constitute as a mortgage fraud, and pretty much invalidate any legal protections that you have.

Of course, usually banks don’t like to resort to legal actions in recovering assets from you. If a market assessment indicates that they are able to recover most of the loan amount, they will probably not go after you, and do a quick Trustee’s sale instead of going through a judicial foreclosure. However, if the housing market turns, there is no guarantee that they won’t go after you in court for a deficiency judgment. A deficiency judgment is where you are personally liable for all the difference or deficiency between the sale of the home and the loan balances (plus all the legal costs and probably mortgage interests).

To read more about the details of trustee’s sale & deficiency judgments, including tax treatments for both, you can follow the links that I’ve found:

  1. Very good information from Weiss & Weissman.
  2. More from San Francisco Chronicles.
MillionaireMan
 

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