Both unsecured and secured personal loans can be recourse debts where the borrower assumes all risk and is personally liable. After liquidating the collateral, any balance that remains is known as a deficiency balance. While potential borrowers may find it attractive to hold out for non-recourse loans, they usually come with higher interest rates.
It may also come with tougher terms, such as a larger down payment on a home or a car. If a lender cancels a debt and issues Form 1099-C, the lender will indicate on the form if the borrower was personally liable (recourse) for repayment of the debt. 5) Make sure you have the proper documentation before applying for a commercial mortgage. This includes personal financial statements, schedule of real estate owned, real estate resume’, and financials of the property. While all these items are usually required, all lenders will have their own documents in addition to these to fill out. In order to qualify for non-recourse financing, commercial lenders often have strict eligibility requirements.
How to Determine Your Loan Type
In this case, the existence of a recourse feature may not provide complete risk mitigation for the lender. Some states may require that all mortgages are nonrecourse debt and in the instance of a default, lenders cannot pursue a deficiency judgment after collateral has been seized. Most lenders do not issue non-recourse loans because doing so exposes them to more risk. However, banks may offer them to specific customers based on financial circumstances or customer needs. As a result, non-recourse loans are likely to have higher rates, larger down payments, or other conditions. A recourse loan is a type of loan, so it must be paid back if it is in the loan’s terms and conditions.
- The bank generally cannot take further legal action to collect the money owed on the debt.
- For example, most reverse mortgages are nonrecourse loans, because financial products targeted at seniors are often afforded greater consumer protection.
- An experienced borrower with a proven investment strategy will typically be in a much better position for a nonrecourse loan compared to a first-time commercial property owner.
- Non-recourse loans have lower risk to the borrower, but typically these loans have higher costs.
A nonrecourse debt (loan) does not allow the lender to pursue anything other than the collateral. For example, if a borrower defaults on a nonrecourse home loan, the bank can only foreclose on the home. The bank generally cannot take further legal action to collect the money owed on the debt.
A Nonrecourse Loan Is Right For You If…
If the borrower defaults, the lender can repossess the car and sell it at fair market value. This amount may be less than the amount owed on the loan because vehicles depreciate significantly in their first couple of years. If there’s a balance left on the loan, the lender can go after the borrower’s other assets to recoup the remainder of the debt.
This is because the debt isn’t tied to the borrower’s income or total assets — as they aren’t involved in non-recourse financing. With recourse debt, banks and other lenders can place a cap on how much debt they can accept, relative to an investor’s personal income. Finally, non-recourse loans can be significantly less complicated for a syndication or partnership. Recourse loans are a type of secured debt that lets lenders recoup defaulted loan balances by seizing both the loan collateral and—when necessary—the borrower’s other assets.
Can Lenders Forgive Recourse Debt?
They are also generally reserved for individuals and businesses with stellar credit histories. A non-recourse loan is not a get-out-of-a-loan-free card; failure to pay off a non-recourse debt has penalties, including loss of the collateral, damage to the borrower’s credit score, and possible taxes. It leaves them vulnerable to losses if their customers default on their loans and their collateral proves insufficient. If there’s a balance due after selling the asset collateralized with the loan, the lender has to take the loss. A recourse loan allows a lender to pursue additional assets when a borrower defaults on a loan if the debt’s balance surpasses the collateral’s value.
Some states have non-recourse mortgage laws, such as North Carolina and Texas. In these mortgage loans, the lenders can foreclose on the home but cannot attempt to seize other assets to make up for the loss. 3) It is also important to remember that not all lenders offer both recourse and non-recourse loans, so you may need to shop around for the best rates and terms. Conversely, a borrower may be able to demand non-recourse debt terms if it can select from many lenders and has such excellent financial results and asset reserves that it can justify its demands. Non-recourse debt poses a greater risk to the lender than recourse debt, especially if the resale value of a loan’s collateral decreases below the owed balance throughout the life of the loan.
Understanding Non-Recourse Debt
If it cannot be paid back in full with interest specified in the contract, the lender can seize other assets to recoup losses. If the borrower fails to live up to their obligation and default on the payment schedule, the lender will first seize and sell the collateral specified in the loan. If that is not of sufficient value to repay the loan amount, the lender can go after the borrower’s other assets or sue to have the borrower’s wages garnished.
Borrowers may find that they can get more competitive rates and terms on non-recourse loans than recourse loans. This is because in some cases, these lenders are willing to take on more risk when lending money that will be bundled up and sold into bonds. Many investors that are buying commercial property will find that the non-recourse loans are limited to loan sizes above $2-3million.
Thomas’ experience gives him expertise in a variety of areas including investments, retirement, insurance, and financial planning. Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia. Click below for a free, no obligation quote and to learn more about your loan options. Lauren is a Content Editor specializing in personal finance and the mortgage industry. Her writing focuses on reporting the best places to live in the U.S. based on certain interests and lifestyles.
With a nonrecourse loan, you’ll never owe more than your collateral is worth. A borrower with near-perfect credit might be able to negotiate with their lender to include a nonrecourse clause at no additional cost while shopping for a mortgage. All others would have to be willing to pay a higher interest rate for a nonrecourse loan. Conversely, recourse debt allows the lender to pursue the borrower for any balance that remains after liquidating the collateral.
When a debt is non-recourse, the lender may liquidate the collateral but may not attempt to collect the deficiency balance. Non-recourse loans are a type of loan where the bank assumes most of the risk. A non-recourse loan is one in which the lender cannot go after more than the collateral offered for the loan.
This is the case even for assets that weren’t identified as underlying collateral for the loan and can include garnishing wages or levying bank accounts to pay off the remaining debt. With a nonrecourse loan, the lender is limited to the collateral itself to recoup losses. Regardless of whether a secured loan is recourse or non-recourse, the lender can seize the borrower’s collateral in the case of default. The primary difference is that with a non-recourse loan, the lender can only seize the specific collateral—even if it’s worth less than the outstanding debt. The main advantage of a non-recourse loan for borrowers is the lack of any personal liability. Another advantage of a non-recourse loan is that it can enable an investor to borrow more.
Even if a lender wins a judgment against a borrower, collecting on the outstanding debt can be expensive and time consuming. If a lender doesn’t think the borrower has substantial assets to tap, it may never actually collect on the outstanding debt. However, you should always try to avoid this outcome by communicating with your lender if you think you may default. After collateral has been seized, a deficiency judgment may levy the borrower’s bank accounts or garnish wages to repay the debt balance. It is important to note that lenders don’t always pursue assets beyond the collateral in default cases, especially by individuals.
A non-recourse loan permits the lender to seize only the collateral specified in the loan agreement, even if its value does not cover the entire debt. Because of the higher risk to lenders, nonrecourse loans carry with them stricter terms. Non-recourse debt is characterized by high capital expenditures, long loan periods, and uncertain revenue streams. Underwriting these loans requires financial modeling skills and sound knowledge of the underlying technical domain. Lenders impose higher credit standards on borrowers to minimize the chance of default.
