For lenders, minimizing risk is the name of the game. That’s why bigger loans have strict requirements and why only the most reliable borrowers get the best interest rates. However, some lenders may go even further in reducing risk by offering recourse loans.
Recourse loans allow the lender to seize many of the borrower’s assets if the borrower fails to repay their loan — even assets that were not included in the loan agreement as collateral. It reduces risk for the lender, which means you may be able to score the lowest rates. But since that risk may mean losing valuable assets, you need to be sure you can repay before you agree to borrow.
Key takeaways
- You are considered personally liable with recourse loans.
- Lenders can seize assets not listed in the loan agreement.
- Less risk for the lender often means lower interest rates.
Types of recourse loans
When you take out a loan, you agree to a contract that specifies what actions the lender can take if you default. Personal loans, auto loans, credit cards and short-term real estate loans are all considered recourse loans.
Most mortgages are also recourse loans. However, there are 12 states that allow nonrecourse mortgages, which means the lender will only be able to repossess the home — not any other assets or sources of income.
All government-backed mortgages are also nonrecourse loans, even if you don’t live in a nonrecourse state. This means the lender cannot come after any assets except for your home if you default on a VA, USDA or FHA loan.
An example of a recourse loan
Let’s say you take out an auto loan to buy a car. If you stop making payments, the lender can legally repossess the vehicle.
If the value of the vehicle is less than the remaining balance on the loan, your lender is able to seize your other assets to recoup its loss. For example, let’s say you took out a car loan and stopped making payments after one year, at which point the lender seizes the car. At this time, the car is only worth $12,000 — but you still have $14,000 left on the loan.
The lender needs $2,000 to break even on the loan. If you have a recourse loan, the lender can then ask a court to garnish your wages until you’ve paid off the $2,000. It may also be able to recoup funds by taking your tax refunds, pension checks, Social Security checks and more.
Recourse loan vs. nonrecourse loan
In short, a recourse loan is when a lender can seize any asset, including and beyond the item used to secure the loan. By contrast, if you default on a nonrecourse loan, the lender can only take the asset associated with the loan.
Because lenders face a potential loss with nonrecourse loans, many do not offer them or reserve them for borrowers with the highest credit scores. They may also have a higher down payment requirement in the case of mortgages or auto loans.
Recourse loans are potentially more damaging to borrowers than nonrecourse loans, but they’re also more popular with lenders. If you’re currently carrying any form of debt, there’s a good chance that it’s a recourse loan.
Should I get a recourse loan?
In general, a nonrecourse loan involves less risk. But they are much more difficult to qualify for. So while your financial situation will determine which is best, in most cases, you may be unable to find a nonrecourse loan.
A recourse loan is a good choice if you want to find a competitive interest rate. They almost always come with more favorable interest rates than nonrecourse loans because there is less risk for lenders if you are unable to repay your debt.
A nonrecourse loan is best if you have an excellent credit score. Lenders typically have higher lending standards for nonrecourse loans and mostly offer them to borrowers who have the best credit scores.
The bottom line
If you already have a recourse loan, your best course of action is to pay your bills on time. If you’re worried about defaulting and have a recourse loan, you should contact your lender and ask about your options.
If you are deciding between a recourse loan and a nonrecourse loan, weigh the pros and cons. You may pay more interest on a nonrecourse loan, so if you have a stable job and low debt-to-income ratio, you may decide to take a small risk and choose a recourse loan.
Frequently asked questions
The 12 states that consider mortgages nonrecourse loans are:
- Alaska.
- Arizona.
- California.
- Connecticut.
- Hawaii.
- Idaho.
- Minnesota.
- North Carolina.
- North Dakota.
- Texas.
- Utah.
- Washington.
It will depend on the laws of your state and your financial situation, but your lender may be able to garnish your wages or seize a high-value asset if you default on a recourse loan.
Like any debt cancellation, there will be tax implications. This is especially true for secured loans like mortgages. If you are personally liable for the debt — which is the case for a recourse loan — you will need to report it on your taxes. In other cases, your tax refund could be garnished to pay back a lender if the sale of the asset wasn’t enough to cover the amount you owe.
FAQs
In short, a recourse loan is when a lender can seize any asset, including and beyond the item used to secure the loan. By contrast, if you default on a non-recourse loan, the lender can only take the asset associated with the loan.
What is an example of a recourse loan? ›
Examples of Recourse Loans
Most automobile loans are recourse loans. If the borrower defaults, the lender can repossess the car and sell it at fair market value. This amount may be less than the amount owed on the loan because vehicles depreciate significantly in their first couple of years.
What is the difference between a recourse and nonrecourse loan? ›
A recourse debt holds the borrower personally liable. All other debt is considered nonrecourse. In general, recourse debt (loans) allows lenders to collect what is owed for the debt even after they've taken collateral (home, credit cards).
What does a full recourse loan mean? ›
Full-recourse debt is a type of secured debt that gives the lender rights to assets—beyond just the secured collateral specified in the loan contract—to cover the full repayment of the borrower's loan obligations if they default on the loan.
What is the risk of recourse? ›
Recourse – Higher risk for borrower (or guarantor) as personal assets beyond the collateral are at risk. Non-Recourse – Higher risk for lender as lender is limited to the collateral as its only means of recovery.
Are mortgages recourse loans? ›
Most mortgages are also recourse loans. However, there are 12 states that allow non-recourse mortgages, which means the lender will only be able to foreclose on the home — not any other assets or sources of income.
Is an SBA loan a recourse loan? ›
SBA has no recourse (or will demand compensation or payment) against individuals, shareholders, members, or partners of an eligible recipient unless the 'covered loan' proceeds are used for unauthorized purposes (see above).
Is a reverse mortgage a non-recourse loan? ›
Reverse mortgages are “non-recourse” loans, which means that if you default on the loan, or if the loan cannot otherwise be repaid, the lender cannot look to your other assets (or your estate's assets) to meet the outstanding balance on your loan.
How do you qualify for a non-recourse loan? ›
Who Can Qualify For a Non-Recourse Loan? Because non-recourse debt poses a greater risk to the lender, a borrower may need high credit scores and a low loan-to-value ratio. The interest rates on non-recourse loans may also be higher to compensate for the risk.
What are the 12 non-recourse states? ›
There are 12 states that, by law, only allow nonrecourse loans. These are known as “nonrecourse states,” and they include Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah and Washington.
The benefit to the lender is that the loan is insured by FHA. The benefit to the borrower is that the loan is at a fixed interest rate, often lower than conventional rates, and is non-recourse.
What does recourse stand for? ›
: a turning to someone or something for help or protection. settled the matter without recourse to law. b. : a source of help or strength : resort.
What are the benefits of a non-recourse loan? ›
The primary benefit of non-recourse loans is that they provide a greater degree of protection for the borrower. Without a personal guarantee, the lender cannot seize the borrower's personal assets if they default on the loan.
What are limitations of recourse? ›
Limited recourse debt is debt, such as a loan, that gives the creditor the legal right to certain, but not all, of the borrower's assets if the borrower defaults. Full recourse debt allows creditors to claim any and all of the borrower's assets to fully cover the unpaid portion of a loan.
Is recourse debt secured? ›
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.
How do you use recourse? ›
Drivers have little recourse but to wait until the weather clears. I have no other recourse than to inform the police. She often had recourse to her dictionary. The mother of an illegitimate child had no legal recourse to the father.
Are hard money loans recourse? ›
Hard money loans are usually secured by physical assets like property and their assessed value in the form of equity. “Hard money loans are generally non-recourse,” says Mills Menser, CEO and founder of Diamond Banc, headquartered in Columbia, Missouri.
What is recourse factoring with example? ›
An example of Recourse Factoring
Let us assume that company A sells ₹1000 worth of goods to Company B, which will pay company A back after three months. Now, company A sends a copy of an invoice to company C, a factoring company, which transfers ₹800 to company A on the same day.
When can a non-recourse loan become a recourse loan? ›
A non-recourse loan can become a recourse loan in several situations, including: Fraud. The misapplication of funds.
What is considered legal recourse? ›
A legal recourse is an action that can be taken by an individual or a corporation to attempt to remedy a legal difficulty. A lawsuit if the issue is a matter of civil law. Contracts that require mediation or arbitration before a dispute can go to court.
