In the mortgage world lenders (defined as any institution that makes home loans including banks) have certain rights and expectations. For example, they expect borrowers to make their payments on time, expect the property to be maintained in a satisfactory manner and so forth. But sometimes, as we know and for a variety of reasons, borrowers cannot make their payments. This results in a loan default and can lead to foreclosure. When this happens the lender may or may not have “recourse” against the borrower. This recourse depends upon what state the property is located in. In some states the law prohibits recourse and these states are called “non-recourse” states.
In recourse states the lender is allowed to pursue the borrower after the borrower defaults on a loan. The lender has the right to come after the borrower for the difference between the loan amount due and the proceeds from the sale of the collateral (property). This difference is called the deficiency balance. It is the amount needed to make the lender whole and have no loss from the transaction. Having the right to take this action does not necessarily mean that the lender will act. The lender may decide that the costs of trying to recover funds is too much and not worth the effort. In addition, bankruptcy laws may offer some protection for consumers in this instance.
In non-recourse states the lender can take no action against the borrower after the borrower defaults and the property is sold. If the sale brings less than the amount owed the lender has “no recourse” against the borrower to collect the difference and therefore takes a loss on the loan. The problem gentle reader is when the lender, or the banking system, starts accumulating losses it affects the lender’s capital structure. As we have seen this can be nearly fatal and has resulted in our government investing billions of dollars to keep the lending system afloat. I guess the good news is that most of the recipients of TARP money have paid it back with the exception of GMAC who is asking for a third bailout.
In today’s crisis lenders have to manage their capital better than ever and especially if they have received aid from the government. The upshot of this is that they have tightened their lending standards from credit cards to autos to home loans (not to mention that commercial and development lending is almost at a standstill). In the housing market this means higher minimum credit scores, lower maximum debt ratios, larger down payments (except for FHA), risk based pricing (matrix’s with credit score and loan to value adjustments), increased documentation, stricter loan disclosure requirements, closer management of the appraisal process, and much more. So while there is still lots of money for home loans to get it you have to be better qualified and prepared for more processing than before. There is no data I could find on how much the concept of recourse has directly impacted the housing market but clearly lenders have had to make adjustments in how they go about their business of producing profits while minimizing losses.
The views expressed are the subjective opinion of the article's author and not of FinancialAdvisory.com
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