Choi Lawyer Talks About Finance

ArabicBulgarianChinese (Simplified)Chinese (Traditional)CzechDanishDutchEnglishFrenchGermanIrishItalianJapaneseKoreanLatvianLithuanianMacedonianMalayMalteseNorwegianPersianPolishPortugueseRomanianRussianSlovakSlovenianSpanishSwahiliSwedishThaiTurkishUkrainianVietnameseWelshYiddish

Recourse Loans vs. Non-Recourse Loans – What’s The Difference?

Choi Lawyer

Choi Lawyer

Recourse Loans vs. Non-Recourse Loan
Share on facebook
Share on twitter
Share on linkedin
Share on pinterest
Share on telegram
Share on reddit

What Is a Recourse Loan?

In recourse loans, the borrower is 100% personally liable for the loan amount. This could result in a lender repossessing or foreclosing the collateral stipulated in the loan agreement. If the lender cannot recoup the entire loan balance from the sale of the collateral, it may file a lawsuit and pursue the borrower’s other assets. 

Some common types of recourse loans include:

✔ Personal loans
✔ Credit cards
✔ Auto loans
✔ Short-term real estate loans.

Recourse Loan Example:

If a borrower takes out a $25,000 auto loan to purchase a $32,000 vehicle, the loan will be secured by the car. Should the borrower, after several payments, default on the loan with $20,000 remaining, the lender may repossess the vehicle and sell it to recoup the outstanding loan amount. However, let us suppose that the car has depreciated and can only be sold for $18,000. In such a case, the lender may also seek a judgment from a court and garnish the borrower’s wages to recover the remaining $2,000.

 

What Is a Non-Recourse Loan?

A non-recourse loan is one where the lender may seize the collateral if the borrower defaults. In contrast to recourse loans, the lender cannot pursue the borrower’s other assets, even if the collateral is of lower value than the balance due. After the collateral is sold, any remaining balance must be written off. Many traditional mortgages are non-recourse loans, which use only the home as collateral. If the homeowner defaults, the lender can seize the home, but not any other assets belonging to the borrower.

Although potential borrowers might find it appealing to hold out for non-recourse loans, these loans typically carry higher interest rates and are reserved for borrowers with solid credit histories.

A borrower who fails to pay off a non-recourse debt still faces penalties, such as the loss of the collateral and damage to their credit rating.

Non-Recourse Loan Example:

A home buyer takes out a mortgage of $200,000 to purchase a house with a value of $250,000. If the homeowner defaults on $180,000 of the loan, the lender can foreclose on the collateralized property to recoup the outstanding balance. If, however, the local real estate market is saturated and the house can only be sold for $170,000, the lender cannot recoup the shortfall of $10,000 through other methods.

 

The Main Difference Between Recourse Loan And Non-Recourse Loan:

Obtaining a recourse loan allows a lender to pursue additional assets of a defaulting borrower if the debt balance exceeds the value of the collateral. In a non-recourse loan, the lender is permitted to seize only the collateral specified in the loan agreement, even if the collateral does not cover the entire amount owed to the lender. As recourse loans pose less risk to lenders, they often have lower interest rates and are more widely available.

 

Recourse Loan Vs. Non-Recourse Loan: Which One Is Better?

Irrespective of whether a secured loan is recourse or non-recourse, the lender may take possession of the borrower’s collateral in the event of default. A non-recourse loan differs from a recourse loan in that the lender may only take the collateral, even if it is worth less than the outstanding debt. However, the lender can take the borrower’s collateral with a recourse loan. If it cannot recoup the outstanding loan balance by selling that collateral, it can go after the borrower’s other assets.

Choosing the right loan option depends on the borrower’s needs, creditworthiness, and confidence in their ability to make timely payments.

Recourse loans are an option if:

✅ You have a poor credit history or a high debt-to-income ratio. Besides having lower interest rates, recourse loans also have more lenient approval requirements. When your credit score is low, or your debt-to-income ratio is high – meaning that a large part of your income goes toward servicing your debt – you are most likely to qualify for a recourse loan.

✅ You are looking for a lower interest rate. For lenders, recourse loans are less risky than non-recourse loans since they have greater flexibility when recouping outstanding debt in the event of default. Because of this, lenders can offer more competitive interest rates on recourse loans than non-recourse loans.

✅ You are taking out a credit card or auto loan. As a general rule, certain types of debt, such as credit cards and auto loans, are structured as recourse debt. Therefore, to qualify for many traditional financing options, borrowers must accept the terms of recourse loans.

Non-recourse loans are an option if:

✅ You can satisfy more stringent requirements for approval. Non-recourse loans are available to borrowers with high credit scores and low debt-to-income ratios.

✅ You are willing to pay a higher interest rate. A higher interest rate protects lenders against riskier non-recourse loans.

 

Conclusion:

From the lender’s perspective, recourse loans reduce the perceived risk associated with less creditworthy borrowers. Lenders may be less concerned about the borrower defaulting on the loan if they have the opportunity to seize additional property beyond the initial collateral. Loans with recourse, such as hard money loans, often become more expensive for borrowers than traditional financing provided by banks at market rates. This is why lenders typically prefer to issue recourse loans while borrowers prefer non-recourse loans.

Share on facebook
Facebook
Share on twitter
Twitter
Share on linkedin
LinkedIn
Share on pinterest
Pinterest
Share on telegram
Telegram
Share on reddit
Reddit
Author Bio

Author Bio

Michael Choi is a senior lawyer practicing in Hong Kong whose background includes international trade and a full range of trade finance products. He’s helped numerous international corporate clients with strategies for raising capital and getting funded. Michael has also been offering free legal advice to the public in Hong Kong since 2011 to offer assistance to those who can’t afford to pay legal fees.

Founder of:
ChoiLawyer
Free Legal Advice
Co-Founder of:
Nugget Global
LoveYourFamily

All Posts

Leave a Reply

Your email address will not be published.

You may also like

Secured Loans Vs. Unsecured Loans
Raise Capital
Choi Lawyer

Secured Loans Vs. Unsecured Loans

There are generally two types of consumer loans available: secured and unsecured. The primary difference between the two is the presence or absence of collateral, which

Read More »
error: Content is protected !!