What’s the difference between recourse and non-recourse states?
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UPDATED: Jan 25, 2012
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The difference between recourse and non-recourse states lies in a lender’s right to pursue a homeowner who defaults for the difference between their home’s value and the balance remaining on the mortgage loan. Recourse states grant lenders more power, whereas non-recourse states protect the borrower from any personal liability upon defaulting on their monthly payments.
In order to best protect themselves, borrowers should know whether or not their state is a recourse state. Recourse states allow lenders to pursue the individual home loan borrower for remaining debt—even after they have collected the promised collateral. This process of pursuing the borrower for additional money is known as a deficiency judgment.
For instance, imagine a borrower who purchased a $100,000 home. The borrower pays off $5,000 of the home loan over several months, but then falls onto hard times and defaults. The lender forecloses on his home, and sells it for $85,000. That sold amount plus the amount the homeowner has already paid only amounts to $90,000, meaning he is still short $10,000. In a recourse state, the lender can file a deficiency judgment against the homeowner and force him to pay back the remaining $10,000.
On the other hand, non-recourse states focus more on the borrower’s rights. In these consumer sanctuaries, borrowers are generally not held liable for anything more than the collateral they promised when originating the home loan. Regardless of how much a piece of property is worth, when a borrower defaults he is not responsible for any difference between his home’s value and the balance on his mortgage loan.
But this comes at a price that affects all borrowers in non-recourse states: higher interest rates.
Since the business of lending in non-recourse states is inherently more risky than if those lenders took their money to recourse states, they make up for lost overhead by charging more interest. Lenders are also far more interested in a home’s loan-to-value (LTV) ration, which is determined by placing the home loan amount over the appraised value of the home. The higher this is, the more likely the lender is to charge higher interest.
A good way to reduce one’s LTV ratio is to put more money down upon taking out a home loan.
The following are non-recourse states:
- North Carolina
- North Dakota
Remember, before making any major financial decision regarding property financing, consult a real estate attorney or a consumer protection group that has the authority to counsel homeowners.