“What happens when the property securing a nonrecourse mortgage is converted to a rental? Is the mortgage converted to a recourse loan?”


In short, no. A nonrecourse mortgage, also called purchase money mortgage, retains it nonrecourse status for the life of the mortgage unless:

  • subordinated to a construction loan; or
  • secured by other property, wholly or in part.

What matters is the purchase money status of the mortgage debt, a condition established at origination. As long as the debt and the property which securing it remain the same, future changes in economic use, occupancy, ownership, further encumbrance or market value of the property does not alter the mortgage’s nonrecourse status.

Defining anti-deficiency protection

A purchase money mortgage arises in two purchase situations:

  • a carryback note on the credit sale of any type of real estate; or
  • a purchase-assist mortgage secured by a one-to-four unit residential property intended to be occupied by the buyer. [California Code of Civil Procedure §580b(a)(2),(3)]

Conversion of the property securing a purchase money mortgage from owner- to tenant-occupied does not change the nonrecourse character of the loan. The circumstances existing at the time a mortgage is originated govern its life-long character as either a nonrecourse purchase-money debt or recourse debt. Later changes in the property’s use through resale, occupancy by others (tenants), or further encumbrance do not affect this. [DMC, Inc. v. Downey Savings & Loan (2002) 99 CA4th 190]

California’s anti-deficiency rules limit a lender’s recovery of unpaid purchase money debt on a default to the value of the secured real estate. That’s true no matter the method of recovery – short sale, deed-in-lieu of foreclosure or foreclosure by a judicial or trustee’s sale.

Those rules also bar the lender from pursuing the buyer, or any other owners of the property who might later formally assume (promise to pay) the mortgage, to collect any part of the debt the lender is unable to recover from the value of the secured property.

Related article:
Anti-deficiency: past, present and future

After-origination changes inconsequential

Thus, in a default on a mortgage secured by property converted to a rental, the holder of the mortgage cannot obtain a money judgment to collect any deficiency in the property’s value so long as:

  • it’s a residential property of one-to-four units;
  • the purchase price was funded by the lender under the mortgage;
  • the buyer occupied or intended to occupy the property as their primary residence at the time of purchase; and
  • the mortgage was not additionally secured by other property or did not become secured later by a substitute property;
  • or
  • the seller carried back a note secured solely by the property sold (regardless of type) in a credit sale to finance its purchase, and that debt was not subordinated to a construction loan.

Further, a new mortgage which funds the payoff or refinance of a purchase-money mortgage inherits the same nonrecourse status for the amount refinanced (except cashed-out amounts), if:

  • the debt incurred in the refinancing is substantially the same debt as the original purchase-money debt; and
  • the refinanced debt is secured by the same property as the original purchase-money debt. [CCP §580b(b)]

Related article:
Cover for your homeowner: an anti-deficiency primer

However, beware the cash-out refinance or further encumbrance (like a HELOC): any principal withdrawal becomes recourse debt. Cash out on a refinance or equity mortgage is fair game for the lender’s collection of a deficiency, but only through a judicial foreclosure or, on a second mortgage, exhaustion of the security by foreclosure of a senior mortgage.

For more on recourse and nonrecourse debt, see the first tuesday Realtipedia volume Real Estate Finance, chapters 43 and 44.