Often when discussing HECM consumer protections, people use the terms non-recourse, government-backed, and government-insured interchangeably. While they all refer to the safety net for reverse borrowers, they do not mean exactly the same thing. The U.S. Department of Housing and Urban Development (HUD) regulates home equity conversion mortgages (HECMs), and the Federal Housing Authority (FHA) insures them. This backing and insurance protects HECM lenders from borrower default, which in turn allows them to pass on unique benefits to consumers. One of those benefits is non-recourse status.
Here is more about non-recourse in a HECM and how it benefits borrowers.
What Does “Recourse” Mean in a Loan?
Recourse is a legal right that allows a lender to pursue the full value of a loan if a borrower defaults. Most loans are recourse, which means that the borrower is responsible to the lender for the full value of the loan, including balance and principal when it comes due.
If a borrower defaults on the balance in a recourse loan, the lender can take the collateral and sell it to apply toward the outstanding loan balance. If any balance remains after the sale, the lender in a recourse loan will try to collect the remaining amount owed. The borrower is liable for the full amount owed.
Consider how recourse loans work with auto loans. A borrower takes a loan for $25,000 to buy a car for $30,000. If the borrower has made some payments but defaults on the loan with a $20,000 balance remaining, the lender will take the car. If the lender repossesses and sells the car for $15,000, the borrower is still responsible for the $5,000 loan deficit. The lender can get a deficiency judgment in the court on the remaining balance and garnish wages or place a lien on other collateral to recoup the full amount owed.
What Makes a Loan Non-Recourse?
A non-recourse loan offers the borrower protections if they default or the loan’s value exceeds the asset’s value when the loan comes due. If a borrower defaults on a non-recourse loan, the lender can take and sell the collateral to satisfy the loan balance. They cannot take other assets or hold the borrower accountable for an amount greater than the asset’s value.
If the proceeds don’t cover what the borrower owes, the lender cannot collect the remaining amount from the borrower. This is true even if the market value of the collateral is less than the loan balance.
Borrowers benefit from non-recourse loans because of the protections they afford. These protections do, however, come with a cost. Non-recourse borrowers pay insurance on their loans that guarantee the lender will also recover their money in the event of a default.
For example, a borrower takes a $300,000 non-recourse mortgage to buy a home with an appraised value of $350,000. After making $50,000 in payments, the borrower owes $250,000 and defaults on the loan. Like a non-recourse loan, the lender can take and sell the collateral, applying the proceeds to the loan balance. But say the lender sells the home for $220,000. They cannot pursue the borrower to recoup the additional $30,000 by seizing additional assets or garnishing wages.
Non-recourse In HECMs
Because the Federal Housing Authority (FHA) insures all home equity conversion mortgages (HECMs), these loans are non-recourse. For the reverse mortgage borrower and their heirs, this means that they will never owe more than the home’s market value when sold to satisfy the loan balance. Whether this sale happens due to a loan default or the loan naturally maturing, a HECM borrower will not owe the lender additional funds, even if their loan balance exceeds the price of the sale. Additionally, if the market value of the home at sale exceeds the balance of the loan, the borrower or their heirs will receive the excess funds.
This article is intended for general informational and educational purposes only, and should not be construed as financial or tax advice. For more information about whether a reverse mortgage may be right for you, you should consult an independent financial advisor. For tax advice, please consult a tax professional.