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To Have Recourse or Not to Have Recourse

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Posted On: 09/02/2008

Q: How do I know if I have a recourse or non-recourse loan on my investment property? I’m thinking of letting one of my properties go.

A: Mortgages typically are recourse loans, an expression that means if the property is sold for less than the loan balance then the lender has a right to sue for any unpaid amount. In practice, while lenders may have a right to sue, deficiency claims against residential borrowers are uncommon. Why? It costs money to sue, and the borrower likely has few dollars or assets that can be taken.

Things get more complex when you look at specifics. For instance, in California there is no recourse if a residential borrower defaults on a “purchase money” mortgage – the loan used to buy the home. However, if the property has been refinanced then there’s no purchase money mortgage (because it was paid off when refinanced) and a lender may be able to make a claim. In some jurisdictions a lender with a recourse loan cannot seek a deficiency judgment when a home has been sold in a non-judicial foreclosure – a foreclosure that did not go through a court.

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You have an investment property. You’re not a residential owner, so foreclosure and bankruptcy rules can be very different when compared with the purchase of a home. It’s expected that investors have a better understanding of real estate and the financial process. The result is that your exposure to a deficiency judgment can be substantially greater than a defaulting homeowner.

What to do? In a foreclosure situation the lender’s goal is to cut losses. If you cannot pay your mortgage, have a real-estate attorney contact the lender and negotiate a deal – one that, if possible, eliminates the potential for a deficiency judgment.

However, be aware that whether there’s a deficiency judgment or not you need to consider another issue: taxes.

The Mortgage Forgiveness Debt Relief Act of 2007 was designed to assure that foreclosed homeowners do not owe federal taxes on unpaid mortgage debt, money that was previously regarded as “imputed” income. The reason for the new law was that the government – like lenders – had little hope of collecting regardless of what the rules said.

As the IRS explains, the 2007 law “applies only to forgiven or canceled debt used to buy, build or substantially improve your principal residence, or to refinance debt incurred for those purposes.” Any unpaid investment mortgage debt does not fit this definition, thus in addition to facing a deficiency judgment you may also owe big money to Uncle Sam.

You say you have “properties.” To a lender that means you have assets. When you applied for a loan you listed your assets, debts and net worth. The lender has a good idea of what you’ve got – and what can be gotten in the event of foreclosure.

On late-night television, in books and in seminars, real-estate investing is often portrayed as simple, easy and a sure way to wealth. It’s just not so, as too many people are now discovering.

Q: I’m 66 and my wife is 63. We’ve been retired for about two years. We’re considering moving into an adult (over-55) community. Would you please comment on the advantages, disadvantages and pitfalls.

A: Over-55 communities are like other forms of real estate: Some will fit your needs, some won’t. The real question is: What needs do you have?

There are some important questions to ask regarding over-55 communities: A very incomplete list might look like this:

• Do you prefer a retirement community or would you prefer to age in place?

• If you buy in an over-55 community, are you buying a deeded real-estate interest that can be bought and sold? Can you use any broker to sell the property?

• Can you “try out” a community by living there for a few weeks? (Think short-term rental units.)

• What recreational facilities are available? Are they actually being used?

• What health and medical care is available? What about costs? What’s the quality of the services being offered?

• Is there a common dining room? Is there a calendar of social events?

• What are the total fees and charges for a month? What are the highest and lowest costs per month, and why are they different?

Given that a moving to an over-55 community can involve major financial and estate issues, it would be wise to speak with an attorney who specializes in elder law before signing any paperwork. This is also a good time to consider a will and living will.

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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