What Are Recourse Loans and Non-Recourse Loans? (2024)

FAQs

What Are Recourse Loans and Non-Recourse Loans? ›

Like recourse loans, a non-recourse loan is secured with collateral in case of default. The main difference is that the lender has no additional recourse after seizing collateral, even if the amount doesn't cover the outstanding balance.

There are two types of debts: recourse and nonrecourse. A recourse debt holds the borrower personally liable. All other debt is considered nonrecourse. In general, recourse debt (loans) allows lenders to collect what is owed for the debt even after they've taken collateral (home, credit cards).

Credit cards, auto loans and hard money loans—typically short-term real estate loans offered by non-bank lenders—are common types of recourse loans. In the case of default, the lender can repossess the vehicle or items purchased with the loan (collateral) and sell them to recoup the outstanding loan balance.

Personal loans, auto loans, credit cards and short-term real estate loans are all considered recourse loans. Most mortgages are also recourse loans.

The main advantage of recourse loans is that they typically offer lower interest rates and can provide the lender with more comfort with the deal at hand. However, the downside is that they can be risky for borrowers because they are personally liable for the loan.

A recourse loan allows the lender to seize the collateral and any other assets the borrower has if they default. Assets that a lender may seize for a recourse loan include deposit accounts and income sources. Resource loan contracts generally outline which assets the lender may pursue.

Recourse factoring is the most common and means that your company must buy back any invoices that the factoring company is unable to collect payment on. You are ultimately responsible for any non-payment. Non-recourse factoring means the factoring company assumes most of the risk of non-payment by your customers.

A non-recourse loan is secured only by the listed collateral. A mortgage is a good example. If you default on your mortgage, the bank can seize the house to recoup their investments, but they can't seize your car or bank accounts.

Recourse loans place the majority of the risk and exposure on the borrower. If the borrower defaults, the lender may seize the property covered by the loan AND go after the borrower's other assets and financial accounts to recover any additional debt.

There are 12 states that, by law, only allow nonrecourse loans. These are known as “nonrecourse states,” and they include Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah and Washington.

What are the disadvantages of a non-recourse loan? ›

The main disadvantages of a non-recourse loan are tied to the loan terms a borrower can receive. Because the risks to a lender are higher than with recourse debt, a lender will typically pass this on in the form of higher interest rates, or lower loan amounts relative to the property value to offset the risk.

Generally nonrecourse loans are not considered at risk for purposes of the at-risk limitations. An important exception applies to qualified nonrecourse financing that is secured by real property used in the activity of holding real property.

Nonrecourse debt or a nonrecourse loan (sometimes hyphenated as non-recourse) is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable.

But in a nonrecourse situation where your lender cancels the remaining debt, you won't have to pay taxes on it. One other tax implication to note: If you're dealing with a foreclosure and your lender sells your home for more than you owe, you might still owe tax on any gain from the sale.

The benefit to the lender is that the loan is insured by FHA. The benefit to the borrower is that the loan is at a fixed interest rate, often lower than conventional rates, and is non-recourse.

The primary benefit of non-recourse loans is that they provide a greater degree of protection for the borrower. Without a personal guarantee, the lender cannot seize the borrower's personal assets if they default on the loan.

If the property happens to decline in value, or if there are major fundamental issues with the property, it becomes the burden of the lender, often as a loss to them. For example, if an individual takes out a non-recourse mortgage on a home and defaults on the payment, the lender can seize the home.