What Is a Recourse Loan?
A recourse loan is a type of secured financing that provides lenders with more muscle to reclaim their investment if a borrower defaults. Unlike non-recourse loans, a recourse loan lets a lender seize not just the collateral but also pursue the debtor’s other assets to cover any deficit. Let’s dive deeper into this powerful financial tool.
Key Takeaways
- Lenders can seize both the collateral and other assets if the borrower defaults on a recourse loan.
- Potentially includable assets might encompass deposit accounts and income sources.
- Specific assets a lender can go after are typically defined in the loan contract.
- Hard money loans often fall under the recourse loan category.
- While lenders have a preference for recourse loans, borrowers generally incline towards non-recourse loans which limit asset seizure to the collateral.
The Power Behind Recourse Loans
Borrowers can opt for a secured loan which mandates providing an asset as collateral. Such secured loans give lenders the authority to seize and sell the asset if the borrower defaults. Recourse loans, found commonly in real estate and automobile financing, afford lenders the flexibility to pursue additional assets beyond the collateral, rendering such assets further at risk.
Recourse loans are beneficial for lender security but can pose a significant risk to borrowers. They permit lenders to claim not just the collateral but also funds from savings and checking accounts, and to garnish wages, commissions, or bonuses of the defaulter. Therefore, recourse loans can diminish broader financial stability upon default.
Loan contracts with recourse terms enumerate permissible assets for seizure and often differentiate between complete and limited recourse—some only permit legally specified asset pursue, while others impose no such limits.
Types of Recourse Loans
Certain types of financing automatically qualify as recourse loans. One common example are hard money loans for real estate purchases. These terms allow lenders to assume property ownership upon borrower default, hoping to resell it at a profitable margin.
Recourse Loan vs. Non-Recourse Loan: Key Differences
While recourse loans offer lenders more substantial security, non-recourse loans confine seizure strictly to the collateral, safeguarding borrowers’ other assets. This means any unrecovered balance post-collateral sale is written off. Many conventional mortgages are non-recourse loans, thus limiting lenders to the seized home in foreclosure scenarios.
Weighing the Pros and Cons
Advantages for Borrowers
- Access to borrowing despite lower creditworthiness
Disadvantages for Borrowers
- Increased risk; lenders can seize additional assets
Advantages for Lenders
- Decreased perceived risk through broader asset claims if defaults occur
Disadvantages for Lenders
- Higher risk pricing, causing potentially higher rates for the borrower
A Practical Example
Imagine a homeowner takes out a $500,000 recourse loan to purchase a property. Suppose the market value of the house falls to $400,000, leading to foreclosure. If unable to sell the home to cover the full loan amount, the lender can go after the borrower’s other assets to recoup the remaining $100,000. This illustrates the potential breadth of financial exposure associated with recourse loans.
Conclusion
Recourse loans empower lenders with robust collection capabilities widening borrowing horizons but pose substantial risks for borrowers. Examining loan agreements, comparing recourse with non-recourse options, and understanding the broader financial implications can build more secure financial management…
Related Terms: secured loan, non-recourse loan, default, collateral, foreclosure.
References
- Internal Revenue Service. “Recourse vs. Nonrecourse Debt”.
- Federal Reserve Board. “Recourse as Shadow Equity: Evidence From Commercial Real Estate Loans”, Page 7.
- Corporate Finance Institute. “Recourse Loan (Debt)”.
- Corporate Finance Institute. “Non-Recourse vs. Recourse Loans”.
