Comparing Non-Recourse Loans and Recourse Loans

Comparing Non-Recourse Loans and Recourse Loans

A non-recourse loan will not hold the balance of a mortgage over your head after a foreclosure. If you default on a home loan, you will be subject to losing the property. The lender will foreclose on the home, list the property for sale and liquidate it to pay the balance on the loan. During this period of time, the mortgage company will incur costs associated with selling the home. If the price they secure on the home does not cover these costs and the remainder of the sum on your loan, you could be held liable. A non-recourse loan removes this liability.

Cost of a Non-Recourse Loan

In general, a non-recourse loan is considered preferable to a recourse loan. Just because the loan type is preferable, though, does not mean it is available. Lenders assume far greater risk in distributing a non-recourse loan because it does not provide a guarantee against loss of funds if foreclosure happens. Without this guarantee, some of the security of the collateral is removed. Securing a loan with collateral would typically reduce the cost of the loan. In this case, the collateral may not be sufficient, so the lender will not reduce the loan cost as much.

Securing a Non-Recourse Loan

Since non-recourse loans are harder to get, you will need to make compromises to secure the loan. One possible compromise is a higher interest rate. This is the most common compromise, but you can keep the cost of the loan lower if you pursue other avenues. Offering a down payment over 20% on the home is one way to reduce the cost. Paying higher amounts monthly to have a shorter loan is another. With a shorter loan, the lender is less likely to lose money in a foreclosure situation down the line.

Tax Implications of Non-Recourse

Not all parts of a non-recourse loan are beneficial. There is the possibility you will have to pay taxes on any forgiven debt if your home is foreclosed on. When you take a loan, you are essentially being given additional income from the lender. Since you pay this back, you are not taxed on the income. Lenders forgive you of your obligation to repay with a non-recourse loan. This means you will have to treat the forgiven amount as income and pay tax on it. If debt is forgiven between 2007 and 2012, however, you will be relieved through the stimulus program.

Opting for a Recourse Loan

Some borrowers will elect recourse loans despite the risk. Recourse loans are cheaper, more flexible and easier to obtain. They are best if you have a very consistent income that can protect you from foreclosure. Having a large amount of savings and a number of investments also offers security on a recourse loan. Recourse loans are most risky during a housing boom or in a bubble market. In this case, the price of the home may drop, and it is more common to lose money in a foreclosure. During a slower housing market, these loans are less risky since homes are more likely to go up in value over time.

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