What is a 'Recourse'

A recourse is a legal agreement by which the lender has the rights to pledged collateral in the event that the borrower is unable to satisfy the debt obligation. Recourse refers to the legal right to collect.

Recourse lending provides protection to lenders, as they are assured to have some sort of repayment, either cash or liquid assets. Companies that issue recourse debt have a lower cost of capital, as there is less underlying risk in lending to that firm.

BREAKING DOWN 'Recourse'

The Impact of Recourse on Borrowers

Recourse provides the legal means for a lender to seize a borrower's assets if he defaults on a debt. If the debt is full recourse, the borrower is liable for the full amount of the debt even to the extent it exceeds the value of the collateralized asset. In most cases, the lender may obtain a deficiency judgment to seize unpledged assets, levy bank accounts or garnish wages.

Recourse loans are distinct from non-recourse loans, which limit the lender to claiming only the specific asset pledged as collateral. Recourse debt is the more common form of debt because it is less risky for lenders, while non-recourse debt is usually limited to longer term loans placed on stabilized and performing assets such as commercial real estate.

Recourse debt has certain tax implications for borrowers. Any part of the debt that is forgiven by the lender must be reported as ordinary income. For example, if a lender forecloses on a house to recover a $150,000 debt and sells it for $125,000, the borrower still owes $25,000. If the lender forgives the $25,000, the borrower must report it as ordinary income.

Regardless of whether a debt is forgiven, the borrower must report a loss or gain based on the difference between the original loan amount and the amount realized in the sale of the asset. In the above example, the $25,000 must be reported as a loss. Losses incurred through the sale of deficient assets are not tax-deductible.

How to Know If a Loan Is a Recourse Loan

Most loans are issued with recourse language included in the loan document. The language specifies the recourse actions that may be taken along with any limitations.

Generally, whether a loan is recourse or non-recourse depends on the state where the loan originated. Most states provide for recourse for mortgage lenders, but it may be restricted in some way. For example, in some states, the deficiency judgment cannot exceed the fair market value of the property.

Consider a home that that has a mortgage balance of $250,000 and a fair market value (FMV) of $200,000. If the lender sells the home at auction for $150,000, it can only recover $50,000, which is the difference between the FMV and the amount owed on the loan. In some states, such as Arizona, California and Oregon, lenders are prohibited from obtaining deficiency judgments.

RELATED TERMS
  1. Full Recourse Debt

    A guarantee that no matter what happens, the borrower will repay ...
  2. Recourse Loan

    A type of loan that allows a lender to seek financial damages ...
  3. Limited Recourse Debt

    A debt in which the creditor has limited claims on the loan in ...
  4. Non-Recourse Finance

    A loan where the lending bank is only entitled to repayment from ...
  5. Non-Recourse Debt

    A type of loan that is secured by collateral, which is usually ...
  6. Without Recourse

    This phrase has several meanings. In a general sense, when the ...
Related Articles
  1. Personal Finance

    Contrasting Non-Recourse And Recourse Loans

    The difference between a recourse and non-recourse loan involves how aggressively a lender can pursue a borrower who defaults on the loan.
  2. Personal Finance

    Explaining Non-Recourse Debt

    Non-recourse debt limits a lender as to what it can and cannot pursue for collateral.
  3. Investing

    Explaining Debt

    Debt is any amount a borrower owes a lender.
  4. Personal Finance

    What Is Collateral?

    Collateral is property or other assets that a borrower offers a lender to secure a loan. If the borrower stops making the promised loan payments, the lender can seize the collateral to recoup ...
  5. Investing

    What are the Five C's of Credit?

    The five C’s of credit are what banks and other lenders evaluate about a potential borrower when making a lending decision. The five C’s are Character, Capacity, Capital, Collateral and Conditions. ...
  6. Personal Finance

    What Does a Lender Do?

    A lender provides funds to another with the expectation those funds will be repaid with interest.
  7. Retirement

    When Are Mortgage Lenders Better Than Banks?

    Individuals seeking a mortgage loan should consider factors or circumstances that may make a mortgage lender a better choice than a traditional bank.
  8. Investing

    Commercial Real Estate Loans

    Obtaining a commercial real estate loan is quite different from borrowing for residential real estate. Here's what to expect and how to get what you need.
  9. Personal Finance

    What Are Mortgage Lenders Allowed To Ask Borrowers?

    Seemingly intrusive or irrelevant questions are actually legal for lenders to ask of mortgage applicants.
  10. Investing

    Explaining Debt Service

    Debt service is a measure of a person or entity’s use of cash to pay interest and principal on debt obligations.
RELATED FAQS
  1. What is the difference between a non-recourse loan and a recourse loan?

    The essential difference between a recourse and non-recourse loan has to do with which assets a lender can go after if a ... Read Answer >>
  2. What is the difference between secured and unsecured debts?

    Learn the differences between secured and unsecured debt; discover how banks buffer risks associated with each type of loan ... Read Answer >>
  3. What are the main categories of debt?

    Learn about the different types of debt available for consumers including secured debt, unsecured debt, revolving debt and ... Read Answer >>
  4. What is the 1003 mortgage application form?

    Learn about the 1003 mortgage application form, what information it requires and why this form is the industry standard for ... Read Answer >>
Hot Definitions
  1. Trumpcare

    The American Health Care Act, also known as Trumpcare and Ryancare, is the Republican proposal to replace Obamacare.
  2. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
  3. Portable Alpha

    A strategy in which portfolio managers separate alpha from beta by investing in securities that differ from the market index ...
  4. Run Rate

    1. How the financial performance of a company would look if you were to extrapolate current results out over a certain period ...
  5. Hard Fork

    A hard fork (or sometimes hardfork) is a radical change to the protocol that makes previously invalid blocks/transactions ...
  6. Interest Rate Risk

    The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between ...
Trading Center