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Recourse loans are a type of secured debt that lets lenders recoup defaulted loan balances by seizing both the loan collateral and—when necessary—the borrower’s other assets. Common types of recourse debt are auto loans, credit cards and, in most states, home mortgages.
In the case of default, the lender can seize and sell the collateral. If that collateral is not enough to cover the outstanding loan balance, the lender can then go after the borrower’s other assets. Recourse loans pose less risk to lenders, so they usually have lower interest rates and are more widely available.
Non-recourse debt also is secured by a borrower’s collateral. However, in the case of default, the lender only can seize the collateral specified in the loan documents and cannot go after the borrower’s other assets. Few banks offer non-recourse loans, but home mortgages are treated as non-recourse loans in 12non-recourse states. Non-recourse debt also has higher interest rates and more restrictive borrower qualifications than recoursebecause non-recourse debt is riskier for lenders.
What Is a Recourse Loan?
With recourse loans, theborrower is 100% personally liable for the loan amount. Therefore, the lender can first 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 lienagainst 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.
Recourse Loan Example
If a borrower takes out a $20,000 auto loan to purchase a $25,000 car, the debt will be secured by the vehicle. If, after several payments, he defaults on the loan with $16,000 remaining on the loan, the lender can repossess the car and sell it to recoup the outstanding loan balance. However, if the car has depreciated and can only be sold for $12,000, the lender can also get a deficiency judgment from a court and then garnishthe borrower’s wages to collect the remaining $4,000.
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.
Non-Recourse Loan Example
Consider a homebuyer who takes out a $250,000 mortgage to purchase a house with an appraised value of $300,000. If the homeowner defaults on $230,000 of the loan, the bank can foreclose on the collateralized property to try to recoup the outstanding debt. However, in some states, if the local real estate market is flooded with inventory and the house can only be sold for $215,000, the lender cannot recoup the additional $15,000 through wage garnishment or other means.
Recourse Loan Vs. Non-Recourse Loan: Which Is Better?
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 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 loansbecause 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.
How to Determine Your Loan Type
Generally speaking, it doesn’t matter whether your loan is recourse or non-recourse unless you are delinquent in your loan repayments. However, if you want to know whether your outstanding home mortgage is recourse or non-recourse, start by determining whether you are in a recourse state as listed above.
If you have another type of debt, like an auto loan or credit cards, you can determine your loan type by reviewing your original loan documents or by contacting your lender directly. If you confirm you have a recourse loan and think you may default, talk to your lender about options to avoid default—like forbearance or loan modification. You should also work with your attorney or accountant to evaluate the implications of default, foreclosure and possible wage garnishment.
