Non-Recourse Loan (Debt) Definition
A non-recourse loan is a category of loan wherein the borrower has to attach some collateral security to the loan contract like property, equipment, bank fixed deposits, etc in order to secure the loan for the lender. In case of default by the borrower, the lender can seize the collateral to clear the dues. The collateral security is generally property.
- The borrower under a non-recourse debt is not personally liable. That means if borrower defaults then the lender can finally recover the dues by seizing the collateral.
- But if the collateral does not cover the full value of the loan then the lender cannot ask the borrower to pay further.
Non-Recourse Loan (Debt) Example
The need to distinguish recourse loan from non-recourse loan arises only if borrower defaults and some money is still owed on the loan. The involvement of collateral security is the basic means to differentiate recourse from the non-recourse loan.
For example, Ms. Jolly and Mr. Happy both individually want to purchase the house. They both took loans of $240,000 to be paid within 2 years by paying $10000 every month.
4.9 (1,067 ratings) 250+ Courses | 40+ Projects | 1000+ Hours | Full Lifetime Access | Certificate of Completion
Mr. Happy purchased the house on a recourse loan i.e. without providing any collateral to the lender hence become personally liable in case of defaults. While Ms. Jolly mortgaged the house purchased against the loan taken. i.e. she provides the house purchased as collateral.
Assume both get defaulted after paying 4-month installments of $40000. i.e. a total of $200,000 remains unpaid. The current market value of the houses is $180,000 only. The lender seized the houses of both the borrowers and recovered $180,000. An amount of $20000 still remains unpaid.
Now Mr. Happy who took a recourse loan has to further pay $20000 from his personal assets but Ms. Jolly is not personally liable to pay any further amount. So while providing a non-recourse debt, it’s the duty of lender to properly check the fair value of the property.
Difference Between Recourse and Non-Recourse Debt (Loan)
| Sr.no. | Recourse Loan | Non-Recourse Loan |
| 1 | Personal liability: Lender can seize the collateral and can claim further money from the borrower’s personal assets if the debt is not settled. | The lender is limited to seize the collateral under loan contract and cannot further demand any more payments. |
| 2 | The lender can rightfully recover all the dues | Lender’s recovery is limited |
| 3 | Lender before offering loans properly checks the credibility and background of the borrower. | The lender checks the current value and future market projections of collateral provided by the borrower. |
| 4 | High amounts can be offered under recourse loans. | The amount of loan is limited up to the value of the collateral. Generally lower than the value of the collateral. |
| 5 | Due to the personal liability of borrowers, the lender usually offers lower interest rates. | The lender tries to charge higher rates of interest due to the higher risk of repayment. |
Anti Deficiency Laws in Non-Recourse Loans
Deficiency law states that if borrower defaults in timely payments, then mortgaged property can be forfeited and subject to sale. Such laws are connected with recourse loans and authorize the lender to pursue legal action against borrowers to obtain complete payment of the loan.
anti-deficiency laws generally applied on a non-recourse loan, works against lenders, and prohibits them from filing any deficiency lawsuits against the borrower. The borrower may get wrongfully benefited as he can just walk away without owing the lender any further amount after the foreclosure sale of the mortgaged property.
Advantages
- In a recourse loan, the borrower guarantees repayment of the loan as and when due. On the other hand in a non-recourse loan, the borrower does not personally sign the contract to become a guarantor of the loan, hence no personal liability or risk for the borrower.
- Generally, the market LTV ratio is limited to 75%. i.e. for a property of $10 million, the lenders will allocate up to $ 7.5 million as the loan amount. As a borrower try to find a property that stands on its own cash flow and the cash flow from property should not be less than 1.25 times the amount of the proposed payment to be made on loan.
- It is a great source of funds to make bigger investments in real estate properties like apartments, complexes, strip malls, etc.
Key Points about Non-Recourse Loan
- A non-recourse loan typically applies to home loans and other commercial mortgages.
- Non-Recourse debt is usually considered when borrower requires a high amount of capital.
- For lending high capital, the lender keeps a guarantee in the form of collateral securities. Collaterals are generally real properties.
- Lenders impose high credit standards on the borrowers
- In the case of defaults, the borrower is not personally liable to make any further payments after foreclosure of the mortgaged property.
- It is provided for long term periods.
- Due to the higher risk of repayment, lenders charge a higher rate of interest.
- Loan to value (LTV) ratios generally do not exceed 75% in the non-recourse loan.
Recommended Articles
This has been a guide to Non-Recourse Loan and its definition. Here we discuss the difference Between Recourse Loans vs Non-Recourse Debt along with examples, advantages, and Anti Deficiency Laws. You can learn more about Corporate Finance from the following articles –
