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 borrower fails to repay a loan.

In both types of loans, the lender is allowed to take possession of any assets that were used as collateral to secure the loan. In most cases, the collateral is the asset that was purchased by the loan. For example, in both recourse and non-recourse mortgages, the lender would be able to seize and sell the house to pay off the loan if the borrower defaults.

The distinction comes into play if money is still owed on the debt after the collateral is sold. In a recourse mortgage, the lender can go after the borrower's other assets or sue to have his or her wages garnished – anything to be made whole, basically. In a non-recourse mortgage, however, the lender is out of luck. If the asset does not sell for at least what the borrower owes, the lender must absorb the difference and walk away; he has no claim on the lender's other funds or funding sources.

Not surprisingly, as a matter of principle, borrowers almost always favor non-recourse loans, while lenders almost always favor recourse loans. While potential borrowers might find it attractive to hold out for non-recourse loans, it is important to remember that they come with higher interest rates and are reserved for individuals and businesses with the best credit. Additionally, failure to pay off a non-recourse debt may leave a borrower's other assets untouched, but the default is still on record, with all that implies for the borrower's credit score (hint: The impact is not a positive one).

For more related reading, check out The Difference Between Default and Delinquency.