In a foreclosure, it's important to know if your mortgage loan is a "recourse loan" or a "nonrecourse loan." The lender (or current loan owner) can get a deficiency judgment if you have a recourse loan.
But if your mortgage loan is nonrecourse, the lender can't get one. With a nonrecourse loan, the lender can foreclose but can't take further action, like suing you for further payment.
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. So, in the case of a mortgage default, the lender forecloses and sells the loan's collateral (the home). If that collateral isn't enough to repay the outstanding loan balance, the lender can then go after the borrower's other assets.
With respect to foreclosure, a debt is considered to be recourse if the lender can get a deficiency judgment.
In a foreclosure, the total debt the borrower owes sometimes exceeds the foreclosure sale price. The difference between the total debt and the sale price is called a "deficiency."
A "deficiency judgment" is a personal judgment that the lender gets against the debtor to recover the deficiency.
Generally, once the lender gets a deficiency judgment, it may collect this amount—in our example, $50,000—from the borrower by doing such things as garnishing wages or levying a bank account.
With a nonrecourse mortgage loan, the lender can't do anything other than foreclose on the property to recoup the money it loaned you. So, the lender can't get 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 lender to obtain a deficiency judgment, but typically restrictions apply. For example, a deficiency judgment is often limited by the property's fair market value.
Because the lender is typically the only bidder at the foreclosure sale, a fair market value limitation, if state law provides one, prevents a lender from making an extremely low bid 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 lenders typically opt to forgo pursuing one.
Or your loan documents might say that the loan is nonrecourse. Not many lenders offer nonrecourse loans, but (again) state law can make mortgage loans nonrecourse.
Review your loan documents and state law, or talk to a lawyer, to find out if your loan is recourse or nonrecourse. Or a HUD-approved housing counselor might be able to help you.
If your state allows deficiency judgments, you can potentially escape liability by filing for bankruptcy. In Chapter 7 bankruptcy, if you qualify, you can discharge the deficiency, 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.