The recourse and the non-recourse of a mortgage decides the extent of the lenders’ ability to collect upon default of the borrower. In a recourse mortgage the lender can collect the debt from the borrower’s unsecured personal assets and from his future income. On the other hand, in a non-recourse mortgage the lender is restricted to the secured asset. He can foreclose, repossess the house, sell and collect the proceeds.
Mainly, mortgage loans in Europe are recourse loans. There is no credit market regulation or procedural rules that bar lenders from a full recourse to the borrowers’ personal assets and future income. The issue of the introduction of non-recourse mortgages has been hotly debated in Europe in recent years in countries like Ireland, Latvia, and particularly in debt ridden Spain. Spain has been the scene of a number of noteworthy developments.
Non-recourse mortgages provide insurance against a unique constellation of circumstances: when the debtor has the ability to pay the debt from non-exempt assets or income but not from the value of the asset. If the borrow cannot pay from other assets, s/he will effectively be judgment proof and a default will occur, even in a recourse mortgage regime; whereas if there is ability to collect from the house then the creditor will be repaid, even if the mortgage is non-recourse. Such mortgages are common in commercial real-estate, but their character in the homeowner context is different and in some sense opposite. In commercial real-estate, the explicit object of the non-recourse feature is to protect the owner from the downside risk of the asset price; it is effectively a variant of limited liability, but with a fixed lien rather than a floating one. The deal is predicated on the assumption that if the value of the asset is below that of the outstanding loan, the borrower will not hesitate to fulfill her obligation through foreclosure. In the case of homeowners, the object of the non-recourse feature is to protect borrowers from financial collapse.
The advantages of such “financial distress” insurance are evident. Risk is transferred to financial institutions such as banks and insurance companies, which are typically far less risk-averse than individual homeowners; furthermore, their ability to foresee, manage and hedge the risk are greater due to greater financial sophistication and large economies of scale in risk management.
Access the complete CESifo DICE Report and find out more information about the following topics:
- Drawbacks of non-recourse mortgages
- Explanation of difference between US and Europe
- Are non-recourse mortgages a constructive policy choice for European countries?