Many private lenders use MoneyThumb's best-selling software, PDF Insights, to make faster and better-informed lending decisions. If you are a seasoned private lender, then you know the difference between a recourse loan and a non-recourse loan. However, many of our readers and investors who are considering becoming private lenders may not completely understand the differences between these two types of loans. We hope the following information will clear up any misunderstanding about what recourse loans and non-recourse loans actually are and how they work.
What Is a Recourse Loan?
With recourse loans, the borrower is 100% personally liable for the loan amount. Therefore, the lender can repossess or foreclose on the loan collateral as specified in the loan agreement. If the lender is unable to recoup the full loan balance by selling that collateral, it can get a deficiency judgment from the courts and go after the borrower’s other assets. This is the case even for assets that weren’t identified as underlying collateral for the loan and can include garnishing wages or levying bank accounts to pay off the remaining debt.
Credit cards, auto loans, and hard money loans—typically short-term real estate loans offered by non-bank lenders—are common types of recourse loans. In the case of default, the lender can repossess the vehicle or items purchased with the loan (collateral) and sell them to recoup the outstanding loan balance. In many cases, the collateral will have already depreciated or been destroyed and the lender will have to get a deficiency judgment for the difference in value. The lender can then attempt to recover its money by seizing the borrower’s other assets.
In all but 12 states, home mortgages are also considered recourse loans. If a borrower is underwater on their mortgage—meaning the outstanding debt is greater than the value of the home—the bank may not be able to recoup all of its money from a foreclosure sale. In this case, the bank can get a deficiency judgment for the difference between the debt and the foreclosure sale price and then garnish the borrower’s wages or file a lien against other assets.
Even if a lender wins a judgment against a borrower, collecting on the outstanding debt can be expensive and time-consuming. If a lender doesn’t think the borrower has substantial assets to tap, it may never actually collect on the outstanding debt. However, you should always try to avoid this outcome by communicating with your lender if you think you may default.
What Is a Non-Recourse Loan?
A non-recourse loan is one where, in the case of default, a lender can seize the loan collateral. However, in contrast to a recourse loan, the lender cannot go after the borrower’s other assets—even if the market value of the collateral is less than the outstanding debt. Even though lenders are limited in their ability to get a deficiency judgment, non-recourse loans still create some personal liability because the lender can seize the underlying loan collateral.
Even so, lenders that extend non-recourse loans are at a greater risk of not recouping the loan balance and interest payments. For that reason, non-recourse loans are not offered by most financial institutions—but some banks, online lenders, and private lenders will extend this type of debt.
Home mortgages—though generally recourse—are non-recourse in 12 states: Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah, and Washington. If a homeowner defaults in one of these states, the lender can foreclose on the collateralized home but cannot go after the borrower’s other assets.
The Difference Between Recourse Loans and Non-Recourse Loans
Regardless of whether a secured loan is recourse or non-recourse, the lender can seize the borrower’s collateral in the case of default. The primary difference is that with a non-recourse loan, the lender can only seize the specific collateral—even if it’s worth less than the outstanding debt. With a recourse loan, however, the lender can seize the borrower’s collateralized assets and—if it can’t recoup the outstanding loan balance by selling that collateral—can then go after the borrower’s other assets.
The best loan option depends on the borrower’s needs, creditworthiness, and confidence in their ability to make on-time payments. You’re likely to get a recourse loan if you:
- Have a weak credit history or a high debt-to-income ratio. In addition to lower interest rates, recourse loans also have more lenient loan approval requirements. If you have a low credit score or have a high debt-to-income ratio—meaning a large percentage of your income goes to debt service each month—you’re most likely to get a recourse loan.
- Want a lower interest rate. Recourse loans are not as risky for lenders as non-recourse loans because lenders have more flexibility when recouping outstanding debt in the case of default. For that reason, lenders can offer more competitive interest rates on recourse loans than they can for non-recourse loans.
- Are taking out an auto loan or credit card. Certain types of debt—like credit cards and auto loans—are typically structured as recourse debt. For that reason, borrowers must agree to recourse loan terms if they want to take advantage of many traditional financing options.
Non-recourse loans may be an option if you:
- Can satisfy more stringent approval requirements. In rare cases, borrowers with a high credit score and a low debt-to-income ratio may be able to get a non-recourse loan.
- Are willing to pay a higher interest rate. Likewise, a higher interest rate protects lenders that are exposed to riskier non-recourse loans.
- Are taking out a home mortgage in a non-recourse state. If you’re in one of the 12 non-recourse states, you’ll automatically get a non-recourse mortgage.
As you can see from the above information, a non-recourse loan is harder to get, except in the non-recourse states we listed above. Whether you are trying to obtain a recourse loan or a non-recourse loan, don't forget to use MoneyThumb's PDF financial file converters to get your bank statements in order to make your potential lender's job easier during the underwriting process.
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