What Is Non-Recourse Debt?
Non-recourse debt is a type of loan secured by collateral, which is usually property. If the borrower defaults, the issuer can seize the collateral but cannot seek out the borrower for any further compensation, even if the collateral does not cover the full value of the defaulted amount. This is one instance where the borrower does not have personal liability for the loan.
Understanding Non-Recourse Debt
Because in many cases the resale value of the collateral can dip below the loan balance over the course of the loan, non-recourse debt is riskier to the lender than recourse debt, which allows the lender to go after the borrower for any balance that remains after liquidating the collateral. For this reason, lenders charge higher interest rates on non-recourse debt to compensate for the elevated risk.
[Important: With non-recourse debt, the creditor's only protection against borrower default is the ability to seize the collateral and liquidate it to cover the debt owed.]
Recourse Versus Non-recourse Debt
Recourse debt gives the creditor full autonomy to pursue the borrower for the total debt owed in the event of default. After liquidating the collateral, any balance that remains is known as a deficiency balance. The lender may attempt to collect this balance by several means, including filing a lawsuit and obtaining a deficiency judgment in court. If the debt is non-recourse, the lender may liquidate the collateral but may not attempt to collect the deficiency balance.
For example, consider an auto lender who loans a customer $30,000 to purchase a new vehicle. New cars are notorious for declining precipitously in value the minute they are driven off the lot. When the borrower stops making car payments six months into the loan, the vehicle is only worth $22,000, yet the borrower still owes $28,000.
The lender repossesses the car and liquidates it for its full market value, leaving a deficiency balance of $6,000. Most car loans are recourse loans, meaning the lender can pursue the borrower for the $6,000 deficiency balance. In the event it is a non-recourse loan, the lender forfeits this sum.
Non-recourse debt is characterized by high capital expenditures, long loan periods, and uncertain revenue streams. Underwriting these loans requires financial modeling skills and a sound knowledge of the underlying technical domain.
To preempt deficiency balances, loan-to-value (LTV) ratios are usually limited to 60% in non-recourse loans. Lenders impose higher credit standards on borrowers to minimize the chance of default. Non-recourse loans, on account of their greater risk, carry higher interest rates than recourse loans.
- Non-recourse debt is a type of loan that is secured by collateral, which is usually property.
- Lenders charge higher interest rates on non-recourse debt to compensate for the elevated risk (i.e., the collateral's value dipping below the amount owed on the loan).
- Non-recourse debt is characterized by high capital expenditures, long loan periods, and uncertain revenue streams.
- Loan-to-value ratios are usually limited to 60% in non-recourse loans.