Recourse Loans Explained: Understanding Borrower Liability

A recourse loan – alternatively known as recourse debt – is a type of loan that makes the borrower 100% liable for any outstanding balance. The loans require collateralCollateralCollateral is an asset or property that an individual or entity offers to a lender as security for a loan. It is used as a way to obtain a loan, acting as a protection against potential loss for the lender should the borrower default in his payments. (as they are secured loans). With an asset on the table to act as collateral, the lender may then repossess the asset and sell it to recover any losses. If the market value of the asset is less than the loan amount, the lender can go after other assets of the borrower to make up for the additional loss. This is true even if the other assets were not used as collateral for the loan.

Summary:

•  Recourse loans make the borrower 100% liable for the loan amount; if the borrower defaults, the lender can pursue other means to recover the money.
• Most mortgages are not recourse loans; however, hard money loans to purchase real estate usually are.
• Lenders can recover the loss from a defaulted loan by going after the borrower’s personal bank accounts and even their regular income.

Example of a Recourse Loan

Let’s say that a small tech repair business owner decides to expand and stop working out of his home. He takes out a recourse loan for $750,000 to purchase a property that he can work out of. Within the first year, his business falters under the weight of outstanding debts. He tries to sell the property, but the building is now worth only about $600,000 because of a decline in the market. The lender can then go after his other property – including his home and his bank account(s)Savings AccountA savings account is a typical account at a bank or a credit union that allows an individual to deposit, secure, or withdraw money when the need arises. A savings account usually pays some interest on deposits, although the rate is quite low. – in order to recoup the additional $150,000 that he owes.

How Lenders Get Their Money Back

Lenders that provide recourse loans are allowed to go after a borrower’s personal, and sometimes company, bank accounts. They are also allowed – most of the time – to go after some of the ways a person earns an income, such as garnishing the individual’s wages until the debt is repaid. The lender may also be able to take money from the individual’s commissions, bonuses, and even their pension or retirement account.

Recourse Loans vs. Non-Recourse Loans

Non-recourse loans use only the asset involved as collateral. For example, mortgagesMortgageA 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. are traditionally non-recourse loans. They use only the home itself as collateral. This means that the lender can only seize the home itself if the borrower fails to repay the loan. The lender can’t go after personal bank accounts or any other asset that the individual owns in order to recover the sum of the loan.

Hard money loans, on the other hand, are classified as recourse loans, even when the loans are used to purchase real estateReal 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..

In some instances, lenders provide recourse loans knowing ahead of time that the borrower likely won’t be able to repay the loan. It is the lender’s goal to get the borrower default so that they can go after the property. The lender pursues this course of action because they believe that they can acquire and sell the property for more than the original loan was worth.

More Resources

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To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below:

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• Debt CapacityDebt CapacityDebt capacity refers to the total amount of debt a business can incur and repay according to the terms of the debt agreement.
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• Private Money LoanPrivate Money LoanPrivate money loans – or simply private money – is a term used to describe a loan that is given to an individual or company by a private organization or even a wealthy individual. The organization or the individual is known as a private money lender.