Did you know that in the State of California mortgage loans are classified as either “Recourse” or “Non-Recourse” loans? Ok, so you are asking what ‘s the difference and why does it even matter – in plain English please …….
Non-Recourse loans are considered purchase money transactions type loans when you buy a property. Recourse type loans are any types of loans attached to your property after the purchase. If you refinanced your property (cash-out or no cash-out), or if you added a 2nd mortgage (HELOC) to your property, these would be considered “Recourse” loans.
A lender can only go after the collateral (your house) attached to the mortgage on a non-recourse loan. On a recourse loan, the lender may go after your property and any or all your personal assets.
From an article at About.com Banking: http://banking.about.com/od/loans/a/recourseloan.htm
“Recourse loans are loans that allow the lender to come after you in case you default. You can contrast recourse loans with non-recourse loans, which create more risk for lenders. Let’s take a look at recourse loans, how they work, and how to identify them.
Recourse Loans – The Recourse
Recourse loans get their name from the fact that lenders have power. They are allowed to go after you for amounts that you owe – even after they’ve taken collateral. If you default on a recourse loan, the lender can bring legal cases against you, garnish your wages, levy bank accounts, and try to collect the amount you owe.
A legal action to collect money after foreclosure is generally called a deficiency judgment.
Non-Recourse Loans
A non-recourse loan does not allow the lender to pursue anything other than collateral. For example, if you default on your non-recourse home loan, the bank can only foreclose on the home. They generally cannot take further legal actions against you. The bank is out of luck even if the sale proceeds do not repay the loan.”
What about the mortgage debt forgiveness you mentioned, you may be thinking. This specifically has to do with a short sale, or selling your house for less than what is owed to the bank or lender. Mortgage debt forgiveness has to do with the IRS not taxing the cancelled debt. If the lender subsequently cancels what you owe, the IRS requires that you report that debt as income because the duty to repay it no longer exists.
The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. This provision applies to debt forgiven in calendar years 2007 through 2012.
From an article on IRS.gov site: http://www.irs.gov/individuals/article/0,,id=179414,00.html
“The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.
This provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion ($1 million if married filing separately). The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.
More information, including detailed examples can be found in Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments. Also see IRS news release IR-2008-17.
The following are the most commonly asked questions and answers about The Mortgage Forgiveness Debt Relief Act and debt cancellation:
Is Cancellation of Debt income always taxable?
Not always. There are some exceptions. The most common situations when cancellation of debt income is not taxable involve:
- Qualified principal residence indebtedness: This is the exception created by the Mortgage Debt Relief Act of 2007 and applies to most homeowners.
- Bankruptcy: Debts discharged through bankruptcy are not considered taxable income.
- Insolvency: If you are insolvent when the debt is cancelled, some or all of the cancelled debt may not be taxable to you. You are insolvent when your total debts are more than the fair market value of your total assets.
- Certain farm debts: If you incurred the debt directly in operation of a farm, more than half your income from the prior three years was from farming, and the loan was owed to a person or agency regularly engaged in lending, your cancelled debt is generally not considered taxable income.
- Non-recourse loans: A non-recourse loan is a loan for which the lender’s only remedy in case of default is to repossess the property being financed or used as collateral. That is, the lender cannot pursue you personally in case of default. Forgiveness of a non-recourse loan resulting from a foreclosure does not result in cancellation of debt income. However, it may result in other tax consequences.
These exceptions are discussed in detail in Publication 4681.
What is the Mortgage Forgiveness Debt Relief Act of 2007?
The Mortgage Forgiveness Debt Relief Act of 2007 was enacted on December 20, 2007 (see News Release IR-2008-17). Generally, the Act allows exclusion of income realized as a result of modification of the terms of the mortgage, or foreclosure on your principal residence.
What does exclusion of income mean?
Normally, debt that is forgiven or cancelled by a lender must be included as income on your tax return and is taxable. But the Mortgage Forgiveness Debt Relief Act allows you to exclude certain cancelled debt on your principal residence from income. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief.”
If you, a friend, a family member or co-worker have questions on these topics, or when you would be able to purchase another property after a short sale or foreclosure, please contact me.
Gregg Mullery
@iMortgageLB
iMortgage Long Beach CA Branch 