Non-Recourse vs. Recourse Loans: Understanding the Difference

Non-recourse vs. recourse loans are two general categories often used when shopping for a real estate loan. There are, of course, many factors to consider when getting a loan, either for a home or a commercial propertyReal EstateReal estate is real property that consists of land and improvements, which include buildings, fixtures, roads, structures, and utility systems. Property rights give a title of ownership to the land, improvements, and natural resources such as minerals, plants, animals, water, etc.. Factors such as the comfort level with the lender, the amount that can be afforded reasonably, and interest rates are all important. However, one of the most important decisions is whether to go with a non-recourse or recourse loan.

There are positives and negatives on both sides of non-recourse vs. recourse loans. Read on to learn what each type of loan involves in order to better determine which is the right choice for you.

Summary: 

• It’s important to understand the differences between non-recourse vs. recourse loans in order to determine which is best suited for an individual.
• Non-recourse loans are riskier for lenders, which means they are more difficult to qualify for and carry higher interest rates.
• Recourse loans are riskier for buyers but they offer lower interest rates.

What are Non-Recourse Loans?

Non-recourse loans are most favorable to borrowers because they put the majority of the riskCredit RiskCredit risk is the risk of loss that may occur from the failure of any party to abide by the terms and conditions of any financial contract, principally, and responsibility on the lender. If a borrower defaults on a non-recourse loan, the lender is only able to take the asset (property) used as loan collateral, nothing else. If the property happens to decline in value, or if there are major fundamental issues with the property, it becomes the burden of the lender, often as a loss to them.

For example, if an individual takes out a non-recourse mortgageMortgageA mortgage is a loan – provided by a mortgage lender or a bank – that enables an individual to purchase a home. While it’s possible to take out loans to cover the entire cost of a home, it’s more common to secure a loan for about 80% of the home’s value. on a home and defaults on the payment, the lender can seize the home. If the home has declined in value, it is the lender’s loss.

Two important things to know about non-recourse loans: they are harder to obtain and they come with higher interest rates than recourse loans. This is the case because non-recourse loans are riskier for the lender. When pursuing a non-recourse loan, know that it’s important to have strong financials and an impressive credit scoreFICO ScoreA FICO score, more commonly known as a credit score, is a three-digit number that is used to assess how likely a person is to repay the credit if the individual is given a credit card or if a lender loans them money. FICO scores are also used to help determine the interest rate on any credit extended.

What are Recourse Loans?

Recourse loans place the majority of the risk and exposure on the borrower. If the borrower defaults, the lender may seize the property covered by the loan AND go after the borrower’s other assets and financial accounts to recover any additional debt.

Let’s take the same example from above. If an individual defaults on a recourse mortgage, the lender may seize the home. The lender may also go after any other sizeable assets the individual owns and even take money from the borrower’s bank accounts to recover any remaining debt. If the individual does not own any other assets or accounts, the lender may even be able to garnish the borrower’s wages until the debt’s been repaid.

Recourse loans are, however, easier to come by and qualify for, and they typically offer lower interest rates.

More Resources

CFI offers the Financial Modeling & Valuation Analyst (FMVA)™Become a Certified Financial Modeling & Valuation Analyst (FMVA)®CFI's Financial Modeling and Valuation Analyst (FMVA)® certification will help you gain the confidence you need in your finance career. Enroll today! certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:

• 5 Cs of Credit5 Cs of CreditThe "5 Cs of Credit" is a common phrase used to describe the five major factors used to determine a potential borrower’s creditworthiness. Financial institutions use credit ratings to quantify and decide whether an applicant is eligible for credit and to determine the interest rates and credit limits for existing borrowers.
• Commercial Real Estate BrokerCommercial Real Estate BrokerA commercial real estate broker is a middleman between sellers and buyers of commercial real estate, helping clients sell, lease, or purchase them.
• Credit Score AnalysisCredit Score AnalysisCredit score analysis is the process through which different companies evaluate an individual’s or a company’s credit score to help determine how creditworthy the entity is. A credit score is significant because it takes into account how many times credit was used and how efficiently it was repaid.
• Real Estate Project FinanceReal Estate Project FinanceProject finance is long-term financing of an independent capital investment, which are projects with cash flows and assets that can be distinctly identified.  Real estate project finance is a classic example.  Other examples of project finance include mining, oil and gas