Just like most people that I know, I cannot afford to buy a house on a single payment. Naturally, I’d have to get a loan to finance a home purchase. Even though I do not plan to buy a house at the moment, I thought I should start doing my homework so I went to my bank to enquire about mortgages. The banker was a very nice person and explained to me in detail about home and mortgage loans, although it simply made me more confused than ever. When I did further research on it, I realized there was much more to it than I ever knew.

The first thing is there are many types of loans out there. I’ve always known about secured loan and non-secured loan, but I also stumbled upon new terms that I’ve never heard of before this – recourse and non-recourse loan for example. In fact, both recourse and non-recourse loan are a form of secured loan. Secured loan is a loan that is guaranteed by a pledge of collateral and the most commonly used collateral is the borrower’s home.

Now, it is common for a creditor to foreclose on the borrower’s home if he or she defaults on the payment. A recourse loan typically allows the creditor to seek payment from the borrower after the foreclosure, if the value of the home is not enough to recoup the loan. Depending on the state, creditors may also sue the borrower in order to collect the amount owed. Home equity loans and refinance loans are almost always recourse loans.

On the contrary, a non-recourse loan ordinarily only allows the creditor to take over the collateral and nothing more. The creditor usually cannot take legal action against you so if the home foreclosed is not enough to cover the loan borrowed, then it is truly the creditor’s (bad) luck. In most cases, property mortgages are a type of non-recourse loan.
This type of mortgage loan, a non-recourse one, is typically seen as a high risk loan for the creditors, especially with the plunging property values in the market nowadays. In order to reduce their risk, creditors would usually only grant non-recourse loans to borrowers with low loan-to-value (LTV) ratio, which reflects the portion of the property that is being financed. A low LTV usually means that the sum borrowed is a lot lesser than the value of the property. If the creditor has to foreclose the property, he is still likely to recover the full amount he loaned out.

Another precautionary move usually made by creditors is to charge higher interest rate on this type of loan. So unless you plan to bail out on your home, taking a non-recourse loan may be a bad idea in the long run as you are essentially paying more. However, in the case that you are not able to pay back the loan and your mortgage value is higher than the value of your home, then you may walk away without any other repercussions except for losing that home. Again, depending on the state that you are in, your creditor may or may not be able to pursue you for the remaining balance.
Walking away from a non-recourse loan may be an easy way out for a financially distressed person, but note that it may affect your credit rating in a bad way. Even if your credits have always been good before that, there may still be negative effects on them, although this can usually be remedied within a few years’ time.

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Category: Finances
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