Non-Recourse Purchase Money Loans in California

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do you agree that a non recourse loan on a single family home is loaned with out financial risk to the borrower... if they do not want to keep their home when the market drops below what they owe, they can walk away with immunity to any financial loss & the most the lender can do is take back the home, & if the borrower has made all their payments on time & have returned the home in the same condition as when they moved in, their credit will not be negatively, by the lender??? my reference is http://wwlaw.com/forecl.htm

Yes, it is true that purchase money loans are largely non recourse in California. However, I do not agree that there is no financial consequence.

First off, there are credit repercussions for up to ten years. Among other things, this will make it more difficult for the buyer to rent the next property they will live in, as well as making it more difficult to obtain financing on the next property they want to purchase, when they really are ready to join the grown-up world.

Second, just because the lender cannot seek a deficiency judgment does not mean that the IRS will not tax them for debt forgiveness. If the lender loses $50,000 in debt forgiveness, they will report it to the IRS, because they want that deduction from income. The IRS will then tax the former owner whatever tax would be due upon the residence. Income from debt forgiveness is ordinary income, and it is fairly likely to boost the taxpayer up in tax bracket in such a case. So now they have to come up with thousands of dollars. If they had those thousands of dollars, they probably wouldn't have lost the property. So now the IRS is looking for other ways to get their money: attaching wages, confiscating other property, etcetera.

I should also note that there are all kinds of exceptions to the law limiting deficiency judgments for purchase money loans. Fraud is one such limitation; if the buyer had to state more income than they in fact make, that would certainly prove to be an interesting case. I don't do it, but that doesn't mean it never happens. Furthermore, just because the buyer doesn't fall into one of the exceptions does not mean the lender will not contend in court that they do. The law doesn't actually prevent the lender from seeking a deficiency judgment; what it says is that they're not entitled to one if certain conditions hold. Proving that proposition in court is expensive, and the lender can always hope that you simply default by not showing up or something similar.

There are very definitely negative consequences. Buying a property is a complex decision, and should not be done lightly, on the basis of "Walk away if it doesn't work out." The consequences, even if not direct, spread out like ripples in a pond when you drop in a stone. Real estate is a fantastic investment, properly approached. With the tax code and the way leverage works, among other things, it trivially beats anything of equivalent risk for potential reward, or alternatively, beats anything of equal potential for reward as far as low risk. But that risk is not and never will be zero. Indeed, it cannot be. Real estate isn't liquid, and you never get to play with someone else's money risk free. That's two of the many reasons why you need competent professionals on your side.

Caveat Emptor

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3 Comments

MD202007 Author Profile Page said:


It is my understanding that in California, wiped (at the foreclosure auction) junior liens have no recourse for monetary recover against the borrower if that wiped loan was a purchase money loan (e.g., "non-recourse"). I understand this to mean that the lender (or a third party buyer who purchased the wiped mortgage and now unsecured promissory note) cannot pursue a deficiency judgment against the borrower, nor try to collect on their "now" unsecured promissory note (unless the loan was a "recourse loan," meaning it was a refi and/or HELOC).

Can you confirm this to be correct, and if so, cite the relevant CA Civil Code?

Thanks, Mitch

MD202007,

You are correct as far as you go. They can still *pursue* such a judgment, but they should not be able to obtain it unless they can show you fall under one of the exceptions (fraud being chief of these, which includes over-stating income)

You'll still get 1099 love notes so that you owe the taxes on the amount they didn't get, you'll still get the big dent on your credit report, and you'll still have to answer yes to some of the thirteen deadly questions on page 4 of form 1003 for future home loans. This is by no means a free pass, only a means of putting a definite end to a disaster.

chris said:

not sure this information is correct. if a loan is non recourse then there is no tax consequence. a bank cannot cancel a debt if there was no recourse to the person that had the mortgage.

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This page contains a single entry by Dan Melson published on July 6, 2008 7:00 AM.

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