Recourse vs. Non-Recourse Loans – The difference between recourse and non-recourse loans is the capacity of the lender to seize the borrower’s assets if the loan is not paid.
Non-recourse loans are to the borrower’s advantage, whereas recourse loans are in the lender’s favor.
When a lender is granted recourse rights in a borrowing agreement, it indicates that the lender can pursue the borrower to repay the loan by seizing selected borrower assets.
As a result, recourse loans refer to a loan arrangement in which the lender can seize the borrower’s assets. In contrast, a non-recourse loan refers to a loan agreement in which the lender cannot seize the borrower’s assets (other than for assets specified as collateral).
Auto loans, credit cards, and, in most states, house mortgages are examples of recourse loans.
The lender has the right to seize and sell the collateral if the borrower defaults. If the collateral is insufficient to satisfy the loan loans, the lender may pursue the borrower’s other assets.
Because lenders are less risky when it comes to recourse loans, they often have lower interest rates and are more commonly available.
A borrower’s collateral is also used to secure a non-recourse loan. However, in the event of default, the lender can only seize the collateral mentioned in the loan agreements and cannot pursue the borrower’s other assets.
Home mortgages are considered non-recourse loans in 12 non-recourse states, even though few institutions provide them.
Because non-recourse loans are riskier for lenders, it has higher interest rates and stricter borrower requirements than recourse loans.
Article Road Map
- Recourse vs. Non-Recourse Loans
- What Are Non Recourse Loans?
- Non-Recourse Loan Example
- What Are Recourse Loans?
- Recourse Loan Example
Recourse vs. Non-Recourse Loans
When looking for a real estate loan, non-recourse vs. recourse loans are two common types. When applying for a loan, whether for a house or a business, several variables are considered.
The lender’s comfort level, the amount that may be fairly afforded, and interest rates are essential considerations.
One of the most crucial decisions is whether to take out a non-recourse or a recourse loan.
Non-recourse vs. recourse loans have advantages and disadvantages on both sides. Continue reading to discover more about each form of loan and evaluate the best option for you.
In the event of failure on a secured loan, the lender can confiscate the borrower’s collateral, regardless of whether the loan is recourse or non-recourse.
The main distinction is that a non-recourse loan allows the lender to seize just the particular collateral—even if it is worth less than the existing debt.
On the other hand, a recourse loan allows the lender to take the borrower’s collateralized assets and then go after the borrower’s other assets if the lender is unable to collect the outstanding loan sum by selling the collateral.
The ideal loan choice is determined by the borrower’s requirements, creditworthiness, and belief in their capacity to make timely payments.
Read Also: 40 Top Loan Terminologies
What Are Non Recourse Loans?
Borrowers choose non-recourse loans because they place the bulk of the risk and obligation on the lender.
If a borrower fails on a non-recourse loan, the lender can only seize the asset (property) used as loan collateral.
If the property’s value drops or serious underlying flaws with the property, it becomes the lender’s responsibility, which typically results in a loss.
If a person takes out a non-recourse mortgage on a residence and fails on payments, the lender has the right to seize the property. It is the lender’s loss if the home’s value has dropped.
Non-recourse loans have two significant characteristics: they are more difficult to get and have higher interest rates than recourse loans.
Because non-recourse loans are riskier for the lender, this is the case. It’s critical to have good financials and a high credit score when applying for a non-recourse loan.
Non-recourse loans may be a possibility if you meet the following criteria:
« Can meet more strict approval criteria.
Borrowers with a good credit score and a low debt-to-income ratio may be eligible to receive a non-recourse loan in exceptional circumstances.
« Are willing to pay a higher interest rate for a longer period of time.
Similarly, lenders that are exposed to riskier non-recourse loans benefit from a higher interest rate.
« Are taking out a non-recourse mortgage on a house.
You’ll receive a non-recourse mortgage if you live in one of the 12 non-recourse states.
>> More: What Is Loan – A Comprehensive Guide
Non-Recourse Loan Example
Consider a homeowner who takes out a $250,000 loan to buy a property with a $300,000 assessed value.
If the homeowner fails on the $230,000 loan, the bank has the option to foreclose on the collateralized property to collect the debt.
However, in some areas, if the local real estate market is oversupplied and the house can only be sold for $215,000, the lender will not recover the remaining $15,000 by wage garnishment or other means.
What Are Recourse Loans?
The borrower bears the majority of the risk and exposure in recourse loans. If the borrower defaults, the lender may confiscate the loaned property and the borrower’s other assets and financial accounts to recoup any outstanding debt.
Let’s use the same example as before. A lender may seize a home if a borrower fails on a recourse mortgage.
To collect any outstanding debt, the lender may go after any other significant assets the debtor has and remove money from the borrower’s bank accounts.
If the borrower has no other assets or accounts, the lender may be entitled to take the borrower’s earnings until the loan is paid off.
On the other hand, recourse loans are easier to obtain and qualify for, and they usually come with lower interest rates.
If you meet the following criteria, you’re likely to be approved for a recourse loan:
« You may have a poor credit history or a high debt-to-income ratio.
Recourse loans offer more relaxed loan approval criteria in addition to reduced interest rates. You’re more likely to receive a recourse loan if you have a low credit score or a high debt-to-income ratio, which means a substantial portion of your monthly income goes to debt payment.
« You’d want to get a cheaper interest rate.
Because lenders have more flexibility in recouping outstanding debt in the event of failure, recourse loans are less riskier for lenders than non-recourse loans. As a result, lenders can offer more competitive interest rates on recourse loans than on non-recourse loans.
« Are you getting a vehicle loan or a credit card?
Credit cards and vehicle loans, for example, are frequently structured as recourse debt. As a result, if borrowers wish to take advantage of numerous traditional financing alternatives, they must agree to recourse loan conditions.
Recourse Loan Example
The debt will be secured by the vehicle if a borrower takes out a $20,000 auto loan to buy a $25,000 automobile.
If he fails on the loan after many payments and there is still $16,000 left on loan, the lender can seize the automobile and sell it to collect the outstanding loan sum.
If the automobile has depreciated to the point where it can only be sold for $12,000, the lender can get a deficiency judgment and garnish the borrower’s earnings to recover the remaining $4,000.
It’s crucial to grasp the distinctions between non-recourse and recourse loans to figure out which is best for you.
Non-recourse loans are riskier for lenders, making them more difficult to get and with higher interest rates. Buyers take on more risk with recourse loans but typically pay lower interest rates.
Unless you are late in your loan repayments, it doesn’t matter whether your loan is recourse or non-recourse. If you want to discover if your current house mortgage is recourse or non-recourse, first determine whether you live in one of the states listed above.
If you have another form of debt, such as a vehicle loan or credit card, you can figure out what type of loan you have by looking at your original loan paperwork or contacting your lender directly.
If you know you have a recourse loan and are worried about defaulting, talk to your lender about forbearance or loan modification as options to prevent default.
You should also consult with an attorney or accountant to assess the potential consequences of default, foreclosure, and wage garnishment.