In a foreclosure, it's important to know if your mortgage loan is a "recourse loan" or a "nonrecourse loan." For recourse loans, the bank can get a deficiency judgment; but for nonrecourse loans, the bank cannot. Usually, whether your mortgage is recourse or nonrecourse depends on your state's laws.
With a recourse loan, the borrower is personally liable for the debt. With respect to foreclosure, a debt is considered to be recourse if the bank is able to get a deficiency judgment against you.
With a nonrecourse mortgage loan, the bank can't do anything other than foreclose on the property to recoup the money it loaned you. So, the bank may not obtain a deficiency judgment even if the sale proceeds don't repay the total debt owed on the loan.
Whether a mortgage loan is recourse or nonrecourse varies from state to state, depending on a particular state's laws. Many states allow a bank to obtain a deficiency judgment, but typically restrictions apply. For example, the deficiency is often limited by the property's fair market value.
Example: If the total debt is $300,000 and bank bids $250,000 at the foreclosure sale and purchases the property using a credit bid, the deficiency is $50,000. Generally, this means the bank could get a deficiency judgment for $50,000 and be able to collect that amount from the borrower. But if the fair market value of the property is really $275,000, the lender could only get a deficiency judgment in the amount of $25,000.
Because the bank is typically the only bidder at the foreclosure sale, a fair market value limitation, if there is one, prevents a bank from making an extremely low bid in order to collect a big deficiency judgment.
Also, some states—like Arizona, California, and Oregon—prohibit deficiency judgments in certain circumstances, such as if the foreclosure is nonjudicial or for purchase money mortgages. In other states, the process for obtaining a deficiency judgment is so burdensome or time-consuming that banks typically opt to forgo pursuing one.
If your state allows deficiency judgments, you can potentially escape liability once the bank get the judgment by filing for bankruptcy.
In Chapter 7 bankruptcy, you can discharge the deficiency, thereby relieving you of the debt. In Chapter 13 bankruptcy, you might have to pay a portion of the owed amount (often a very small portion). When you complete all of your plan payments, the deficiency judgment will be discharged along with your other dischargeable debts.
If you're facing a foreclosure and want to find out if your mortgage loan is recourse or nonrecourse, as well as learn whether you have any possible defenses to the foreclosure, consider talking to a local lawyer. Also, it's a good idea to consider making an appointment to talk to a HUD-approved housing counselor to get information about different ways to avoid a foreclosure.