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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. Common types of recourse debt are auto loans, credit cards and, in most states, home mortgages.
In the case of default, the lender can seize and sell the collateral. If that collateral is not enough to cover the outstanding loan balance, the lender can then go after the borrower’s other assets. Recourse loans pose less risk to lenders, so they usually have lower interest rates and are more widely available.
Non-recourse debt also is secured by a borrower’s collateral. However, in the case of default, the lender only can seize the collateral specified in the loan documents and cannot go after the borrower’s other assets. Few banks offer non-recourse loans, but home mortgages are treated as non-recourse loans in 12 non-recourse states. Non-recourse debt also has higher interest rates and more restrictive borrower qualifications than recourse because non-recourse debt is riskier for lenders.
When taking out a loan, one of the most important things to understand is whether it is a recourse or nonrecourse debt The type of loan you get can have huge implications if you ever run into issues with repayment. As a borrower, you need to know your rights and responsibilities when it comes to these two types of loans In this comprehensive guide, we’ll explain everything you need to know about recourse vs nonrecourse loans.
What is a Recourse Loan?
A recourse loan means that the borrower is personally responsible for repaying the full amount owed, even if the collateral securing the loan is insufficient. With a recourse loan, the lender can seize the collateral and liquidate it. If the proceeds don’t cover the outstanding balance, the lender can then go after the borrower’s other assets to recoup the deficiency
Some examples of common recourse loans include
- Credit cards
- Auto loans
- Personal loans
- Home mortgages (in most states)
Let’s look at an example of how a recourse loan works:
Sarah takes out a $20,000 auto loan to buy a car worth $25,000. The car is used as collateral on the loan. After a few years, Sarah defaults with $16,000 still owed on the loan. The lender repossesses the car, but since it has depreciated in value, it only sells for $12,000 at auction. With a recourse loan, the lender can sue Sarah for the $4,000 deficiency balance. The lender can garnish her wages or put liens on her other assets to collect the amount owed.
Even if the lender doesn’t take action to collect right away, Sarah remains personally responsible for repaying the deficiency balance. With a recourse loan, the borrower is always on the hook for the full loan amount.
What is a Nonrecourse Loan?
A nonrecourse loan only allows the lender to seize the collateral securing the loan if the borrower defaults. The lender cannot go after any other assets belonging to the borrower, even if the collateral is insufficient to cover the outstanding balance.
Some examples of nonrecourse loans include:
- Commercial real estate loans
- Home mortgages in certain states
- Some small business loans
Here’s an example of how a nonrecourse loan works:
Jeremy takes out a $250,000 mortgage loan to buy a house valued at $300,000. A few years later, Jeremy defaults with $230,000 still owed on the loan. Unfortunately, real estate values have dropped. The lender forecloses on the home and sells it for $215,000, leaving a $15,000 deficiency.
With a nonrecourse mortgage, the lender cannot come after Jeremy for the $15,000 shortfall. The lender can only seize the collateral (the house), even though it didn’t cover the full loan balance. Jeremy isn’t personally responsible for repaying the deficiency amount.
Key Differences Between Recourse and Nonrecourse Loans
Now that you understand the basics of recourse and nonrecourse loans, let’s summarize some of the key differences:
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Personal liability – With a recourse loan, the borrower is personally responsible for the full debt amount. With a nonrecourse loan, the borrower’s liability is limited to the collateral.
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Seizing assets – For a recourse loan, the lender can seize the collateral plus go after any other assets from the borrower. For a nonrecourse loan, the lender can only take the collateral.
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Deficiency judgments – If selling the collateral doesn’t cover a recourse loan balance, lenders can obtain a deficiency judgment against the borrower. Deficiency judgments are not possible with nonrecourse loans.
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Interest rates – Recourse loans generally have lower interest rates because they pose less risk to lenders. Nonrecourse loans have higher rates to account for the increased risk.
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Qualifying – It’s typically easier to qualify for a recourse loan given the lower risk for lenders. Nonrecourse loans have more stringent approval standards.
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Availability – Most lenders offer recourse loans, while only some provide nonrecourse options. Nonrecourse loans are rare outside of mortgages and commercial real estate.
Recourse vs Nonrecourse Mortgages
One area where recourse vs nonrecourse loans gets confusing is when it comes to mortgages. In most states, mortgages are recourse loans – lenders can go after borrowers for deficiencies.
However, there are 12 nonrecourse mortgage states:
- Alaska
- Arizona
- California
- Connecticut
- Idaho
- Minnesota
- North Carolina
- North Dakota
- Oregon
- Texas
- Utah
- Washington
In these states, mortgages are treated as nonrecourse debts secured only by the home. Lenders cannot pursue borrowers for deficiencies.
It’s important to understand your state’s laws regarding mortgage recourse vs nonrecourse when considering the risks of a mortgage default. Those in nonrecourse states have added protection.
Which Type of Loan is Better?
There is no definitive answer to whether recourse or nonrecourse loans are better across the board. Each type has pros and cons that depend on your specific situation as a borrower.
Recourse loans tend to be better if:
- You want lower interest rates
- You have poor credit or high debt levels
- You need a type of loan that is recourse by nature (e.g. credit cards, auto loans)
- You are highly confident in your ability to repay
Nonrecourse loans tend to be better if:
- You want to limit personal liability
- You are willing to accept higher interest rates
- You live in a nonrecourse state for mortgages
- You meet stringent credit and income requirements
Evaluate your own scenario to determine what type of loan best suits your needs and financial situation. If you take out a recourse loan, be cautious and make payments on time, as defaulting can open you up to deficiency judgments.
How to Check if Your Loan is Recourse or Nonrecourse
If you already have an existing loan, how can you tell if it’s recourse or nonrecourse?
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Mortgages – Check if your state is one of the 12 nonrecourse states listed earlier. If yes, your mortgage is nonrecourse. If not, it’s likely a recourse loan.
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Other loans – Check your original loan documentation for any mention of recourse vs nonrecourse language. You can also call your lender directly to inquire about the type.
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Auto and credit cards – These loans are almost always structured as recourse debt. Check documents to confirm, but expect them to be recourse.
Managing Recourse Loans to Limit Risk
If you have recourse loans, take steps to manage the risk of deficiency judgments:
- Prioritize making payments on time
- Build up emergency savings to deal with job loss or expenses
- Refinance high-interest debt to lower payments
- Consider debt consolidation to simplify payments
- Communicate proactively with lenders if struggling
- Consult credit counselors if facing hardship
- Understand consequences of default before stopping payment
While recourse loans can put more of the borrower’s assets at risk, you can take actions to prevent default and reduce your exposure.
Key Takeaways on Recourse vs Nonrecourse Loans
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Recourse loans allow lenders to go after personal assets for deficiencies while nonrecourse loans only permit seizing collateral.
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Most common loans like mortgages, credit cards, and auto loans are recourse debt except for mortgages in 12 nonrecourse states.
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Nonrecourse loans have higher interest rates and stricter approval requirements compared to recourse loans.
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Evaluate your specific situation to decide if a recourse or nonrecourse loan is a better option.
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Take steps to prevent defaulting on recourse loans since you can be held personally liable for balances.
Understanding the difference between recourse and nonrecourse lending can help you make informed borrowing decisions and manage repayment risk. Consider the pros and cons carefully when choosing loan types.
What Is a Recourse Loan?
With recourse loans, the borrower is 100% personally liable for the loan amount. Therefore, the lender can first repossess or foreclose on the loan collateral as specified in the loan agreement. If the lender is unable to recoup the full loan balance by selling that collateral, it can get a deficiency judgment from the courts and go after the borrower’s other assets. 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.
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. In many cases, the collateral will have already depreciated or been destroyed and the lender will have to get a deficiency judgment for the difference in value. The lender can then attempt to recover its money by seizing the borrower’s other assets.
In all but 12 states, home mortgages are also considered recourse loans. If a borrower is underwater on their mortgage—meaning the outstanding debt is greater than the value of the home—the bank may not be able to recoup all of its money from a foreclosure sale. In this case, the bank can get a deficiency judgment for the difference between the debt and the foreclosure sale price and then garnish the borrower’s wages or file a lien against other assets.
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.
If a borrower takes out a $20,000 auto loan to purchase a $25,000 car, the debt will be secured by the vehicle. If, after several payments, he defaults on the loan with $16,000 remaining on the loan, the lender can repossess the car and sell it to recoup the outstanding loan balance. However, if the car has depreciated and can only be sold for $12,000, the lender can also get a deficiency judgment from a court and then garnish the borrower’s wages to collect the remaining $4,000.
What Is a Non-Recourse Loan?
A non-recourse loan is one where, in the case of default, a lender can seize the loan collateral. However, in contrast to a recourse loan, the lender cannot go after the borrower’s other assets—even if the market value of the collateral is less than the outstanding debt. Even though lenders are limited in their ability to get a deficiency judgment, non-recourse loans still create some personal liability because the lender can seize the underlying loan collateral.
Even so, lenders that extend non-recourse loans are at a greater risk of not recouping the loan balance and interest payments. For that reason, non-recourse loans are not offered by most financial institutions—but some banks, online lenders and private lenders will extend this type of debt.
Home mortgages—though generally recourse—are non-recourse in 12 states: Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah and Washington. If a homeowner defaults in one of these states, the lender can foreclose on the collateralized home but cannot go after the borrower’s other assets.
Consider a homebuyer who takes out a $250,000 mortgage to purchase a house with an appraised value of $300,000. If the homeowner defaults on $230,000 of the loan, the bank can foreclose on the collateralized property to try to recoup the outstanding debt. However, in some states, if the local real estate market is flooded with inventory and the house can only be sold for $215,000, the lender cannot recoup the additional $15,000 through wage garnishment or other means.
Recourse vs. Non-Recourse Debt
FAQ
What is an example of a recourse loan?
What is the difference between a recourse and nonrecourse loan?
What are the disadvantages of a non-recourse loan?
Is an SBA loan recourse or nonrecourse?
What is recourse vs nonrecourse debt?
Between recourse vs. nonrecourse debt, recourse debt favors the lender while nonrecourse debt favors the borrower. Hard money loans, which are typically based on the value of the collateral rather than just the creditworthiness of the borrower, tend to be recourse loans. An auto loan is one example of a recourse loan.
Is a mortgage a recourse or nonrecourse loan?
Whether a debt is a recourse or nonrecourse loan often depends on state law. 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.
What is the difference between a secured loan and a non-recourse loan?
Secured loans, where specific assets are pledged as collateral, form the basis of both recourse and non-recourse loans. The distinction lies in how much further the lender can go in recovering the loan amount in the event of a default.
What is a non-recourse loan?
A non-recourse loan is one in which the lender cannot go after more than the collateral offered for the loan. This type of loan is beneficial for the borrower because the lender cannot seize other assets to recoup their losses. What Is an Example of a Non-Recourse Loan? Some states have non-recourse mortgage laws, such as North Carolina and Texas.