Non-Recourse Purchase Money Loans in California
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
UPDATED article here
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» There is No Such Thing as a Risk Free Investment from Searchlight Crusade
I got an email asking me about whether purchase money loans were risk free, as in the buyer could walk away without consequence. Well, it's not the case: There are consequences to credit, tax consequences, and consequences to future financial... Read More
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Dan,
Thanks for the helpful info. I have a question to further clarify this subject.
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 of the wiped mortgage/promissory note) cannot pursue a deficiency judgment against the borrower, nor try to collect on their "now" unsecured promissory note via collections efforts (unless the loan was a "recourse loan," meaning it was a refi and/or HELOC).
Can you confirm this to be so, and if so, please provide me with the CA Civil Code.
Thanks, Mitch
I have a an odd situation that I am hoping you might be able to give me some guidance on. My husband and I are approx 130,000 upside down on a condo that my husband and I purchased in 2005 as a primary residence. We lived there 2.5 year (8/2005-4/2008) until we started having children and purchased a home because we were in need of more room. We have a 1st and a 2nd mortgage on the condo. Both are purchase money loans (which I understand to be non-recourse loans b/c they were used to purchase our home at the time and were never refinanced).
At the time we moved out of the condo, we were unable to sell the condo because we didn’t have the cash to sell it outright at such a big loss. We rented it in 5/2008 with the intention of “waiting out” the bad economy. Well, it’s gotten worse and we are currently losing $1300/mo ($15,000 yr) on the condo because the money expense to keep the condo is much more than the income. We did live in the condo for 2.5 years and then bought a house in Poway with my husband's VA loan.
I have tried to call the banks that hold the loans and have been told that since I do not have any credit card debt and do not have any financial distress they won’t help lower the principal or even lower the high interest rates (b/c of this, I have been told I would be unlikely to be approved for a short sale as well). I am now looking at either Deed in Lieu or just Foreclosure. I understand this will affect my credit, but we have a house and two newer cars, so I don’t foresee a dire need for credit in the next couple of years. What I want to be sure of is that both 1st and 2nd condo loans (Purchase Money Loans) are indeed non-recourse and that I don’t have any worry about the banks coming after any other assets if we intentionally default on the loan. I also wanted to see what the tax implications are (if any) based on the above circumstances.