Non-recourse finance is a type of commercial lending that entitles the lender to repayment only from the profits of the project the loan is funding and not from any other assets of the borrower. Such loans are generally secured by collateral.
A non-recourse loan, more broadly, is any consumer or commercial debt that is secured only by collateral. In case of default, the lender may not seize any assets of the borrower beyond the collateral. A mortgage loan is typically a non-recourse loan.
Key Takeaways
- Non-recourse financing entitles the lender to repayment only from the profits of the project that the loan is funding.
- No other assets of the borrower can be seized to recoup the loan upon default.
- Non-recourse financing typically requires substantial collateral and a higher interest rate and is typically used in land development projects.
Dive Deep into Non-Recourse Finance
Non-recourse financing is a branch of commercial lending that is characterized by high capital expenditures, distant repayment prospects, and uncertain returns.
Consider this scenario: a company wants to build a new factory. The borrower presents a bank with a detailed plan for the construction, in addition to a business plan for the greatly-expanded production capabilities that the factory will facilitate. Repayment can occur only when the factory is operational and exclusively out of the profits generated from production.
The lender agrees to terms stipulating no access to borrowers’ assets beyond the agreed collateral, even in the event of default. Payments are made only if and when the funded project generates revenue. If a project generates no revenue, the lender receives no repayment on the debt. Once the collateral is seized, the bank cannot pursue the borrowers further to recoup remaining losses.
Where Are Non-Recourse Loans Used?
Comparatively, conventional loans demand immediate and installment-based monthly repayments. Interest rates are generally higher on non-recourse loans to mitigate the elevated risk, and significant collateral is essential.
Non-recourse loans are frequently utilized to fund commercial real estate projects and other ventures involving extended lead times to completion. In real estate, the land acts as collateral. Additionally, these loans are prevalent in the financial industry, where securities serve as collateral.
Special Considerations for Non-Recourse Loans
In the U.S., non-recourse loans and recourse loans undergo different tax treatments. Non-recourse loans are deemed fully repaid when the underlying asset is seized, regardless of its sale price.
For recourse debt, if a financial institution forgives any part of the debt after the associated asset is seized and sold, the forgiven amount may be treated as ordinary income, which the debtor must report to the Internal Revenue Service.
Are Non-Recourse Loans Taxable?
If you default on a non-recourse loan, the amount forgiven or canceled is not taxed.
Industries That Benefit From Non-Recourse Loans
Non-recourse loans are notably popular in the real estate sector, as well as other industries characterized by lengthy project durations. During the early stages with potentially negligible income, non-recourse loans provide breathing room to project financiers.
Can a Lender Seize My Personal Assets with a Non-Recourse Loan?
No. non-recourse loans are secured solely by specific collateral. A mortgage exemplifies this — if you default on your mortgage, the bank can seize your house but cannot claim your car or bank accounts.
The Bottom Line
Non-recourse loans provide valuable benefits to businesses planning substantial projects by fostering appealing tax considerations and enabling avoidance of payment obligations until projects reach fruition. While defaulting on a loan is never desirable, a non-recourse loan offers solidity by protecting your other assets from liability in the event of default.
Related Terms: recourse loan, collateral, venture capital, capital expenditure, real estate investment.
References
- Internal Revenue Service. “Recourse vs. Nonrecourse Debt”.
- Internal Revenue Service. “Home Foreclosure and Debt Cancellation”.
