Recourse and Non-Recourse Loans

I love it when people comment who know more about the subject at hand than I do. Commenter Mike explains the differences among loans (and states):

Debts are categorized as either “recourse” or “non-recourse”. Under a “non-recourse” debt, the lender may look no further than the collateral at hand. These are rare in personal loans, but common for businesses. Under “recourse” debt, after seizing and selling the collateral, the lender may still pursue other avenues of collection to make themselves whole. A car loan is typically “recourse” as are your credit cards.

States fall into 3 categories with regards to statutes governing residential mortgage:

  • All residential mortgages are non-recourse. That is, when the banks take the house, there is no longer an enforceable legal debt.
  • Banks may choose either: (a) An expedited and cheaper foreclosure process (usually called non-judicial foreclosure), but in so doing they forgo the enforceability of the balance, or (b) A lengthy and expensive process (called judicial foreclosure) under which they eventually get the house and a judgment for the balance. As a practical matter, the bank almost always picks (a).
  • States that are silent on the matter, in which case the mortgage contract is generally full recourse – that is, after taking the house they may pursue a judgment for the shortfall and enforce the judgment.

Because of this difference in statute, mortgage rates vary from state to state. One can argue that part of what the Arizona resident (case 2) is buying when their mortgage costs 0.25% more than the New York resident (case 3) is the fact that the borrower’s losses are limited to loss of property in Arizona, but not in New York.

In retrospect, the lenders grossly underpriced this risk premium from state to state, but as much as walking away feels wrong, there is an actual statutory difference (at least in Type 1 and maybe Type 2) states between that and stealing.

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2 Responses to Recourse and Non-Recourse Loans

  1. Luis says:

    But even in the type 2 and type 3 states, that was not something that happened to the lenders by accident. It was a known condition of the lender entering into the agreement. It isn’t stealing; it is breaking the contract with pre-negotiated penalties for doing so. Those are two vastly different things.

  2. Nightowl says:

    You say that a car loan loan is typically a “recourse” loan. However, Texas is a nonrecourse loan state and car loans are no different. Typically a loan agency will ask for a larger down payment because of that. What the loan agency can do is forgive the debt and send the outstanding amount to the I.R.S. in which the outstanding amount will be income to you, however the loan agency must give you title to the auto before it is considered income to you. Therefore the only recourse the loan agency has is to repoll the auto or it can send the title to you in your name as a gift and write the outstanding amount off their taxes. This in turn leaves you free of any claim the I.R.S. has towards you in terms unpaid debt as income. The loan agency wins you win and the I.R.S. can go to Helen Wait.

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