DEFINITION of Recourse Loan
A recourse loan is a type of loan that allows a lender to seek financial damages if the borrower fails to pay the liability and if the value of the underlying asset is not enough to cover it. A recourse loan lets the lender go after the debtor's assets that were not used as loan collateral in case of default.
BREAKING DOWN Recourse Loan
Recourse loans give lenders a higher degree of power because they have fewer limits on what assets lenders can go after for loan repayment. For example, suppose that a homeowner takes out a recourse loan for $500,000 to purchase a home and then goes into foreclosure when the local housing market declines. If the value of the home is now only $400,000 and it was purchased with a recourse loan, the lending institution can target the borrower's other assets in order to make up for the outstanding $100,000.
How Lenders Reclaim Funds Through a Recourse Loan
The terms of a recourse loan grant the lender the right to tap into certain income sources of the borrower. This can include garnishing their wages. The lender could pursue compensation by drawing funds from the borrower’s financial accounts, such as a savings or checking account.
Certain types of financing can be classified as recourse loans. Hard money loans for real estate acquisitions would be considered recourse loans. The terms of a hard money loan are built around giving the lender the opportunity to take possession of the property in the event of default and resell it for themselves. The lender might agree to provide this financing with the hope of taking ownership of the property because they believe they can resell the real estate for a greater gain. A hard money loan may be more expensive than loans available at the going rate offered by banks.
Lenders who offer hard money loans might approve borrowed that other institutions would not. Borrowers with limited or poor credit history might turn to hard money loans. The leniency regarding approvals comes with a caveat for the borrower. The lender could pursue their assets in the event of a default. There can be limits on the types of assets the lender can attach to the loan.
The use of recourse loans can reduce the perceived risk associated with lending to certain borrowers. The potential for the lender to seize property beyond the initial collateral can quell some concerns that the borrower will not make good on his or her debt.