Recourse Loans vs. Non-Recourse Loan: An Overview
The essential difference between a recourse and non-recourse loan has to do with which assets a lender can claim against if a borrower fails to repay a loan.
Many loans are taken out with some form of collateral, or assets of a certain value that the lender can take if the borrower does not pay the money back as outlined in the loan. Steps for the collection of assets or the loan's collateral are also often spelled out in the loan, as well as through local laws.
In both recourse and non-recourse 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.
Contrasting Non-Recourse And Recourse Loans
- Both recourse and non-recourse loans have to do with the collection of assets after a borrower fails to repay a loan.
- After collateral is collected, lenders of recourse loans may still go after a borrower's other assets if they have not recouped all of their money.
- With a non-recourse loan, lenders can collect the collateral, but may not go after the borrower's other assets; in other words, they have no further recourse.
The distinction between recourse loans and non-recourse loans 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.
Recourse loans give lenders a higher degree of power because they have fewer limits on what assets lenders can claim against for loan repayment. From the lender's point of view, a recourse loan reduces the perceived risk associated with less creditworthy borrowers.
In a non-recourse loan or mortgage, however, the lender is out of luck. If, after selling the asset collateralized with the loan, there is still a balance due, the lender has to take the loss. He has no claim on the borrower's other funds, possessions, or funding sources. Many traditional mortgages are non-recourse loans, using only the home itself as collateral.
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—which is not a positive one.