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Non-Recourse Loan

Updated on March 19, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Non-Recourse Loan?

A non-recourse loan refers to the type of financing for borrowers where they have to back the borrowed amount against security, also termed collateral. This, in turn, assures lenders that in the event of default, they will have the borrowers’ property to get back the amount.

What Is A Non-Recourse Loan

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The collateral, in this case, is normally the property or project that borrowers invest in. The non-recourse loan definition differs from the recourse loan as the latter holds borrowers personally liable for missed repayments, giving the lenders the liberty to use any of their assets to get back the lent amount in case of default.

Key Takeaways

  • A non-recourse loan is backed by collateral, which the lenders use to cover up the loan amount in the event of defaults. The rest fall under recourse loans.
  • It is a great source of funds to invest in properties like apartments, complexes, strip malls, etc.
  • For high lending capital, the lender keeps a guarantee in collateral securities. Collaterals are generally real properties.
  • Due to the higher risk of repayment, lenders charge a higher interest rate.

How Do Non-Recourse Loans Work?

A non-recourse loan is a category wherein the borrower has to attach some collateral security to the loan contract, like property, equipment, bank fixed deposits, etc., to secure the loan for the lender. Collateral security is generally the property in which the borrowed amount is invested. In default, the lender can seize the collateral to clear the dues.

The borrower under a non-recourse debt is not personally liable. That means if the borrower defaults, the lender can finally recover the dues by seizing the collateral. But if the collateral does not cover the full value of the loan, the lenders cannot ask the borrowers to pay further.

The need to distinguish a recourse loanRecourse LoanA recourse loan is a form of loan in which the lender has the right to recover the whole amount loaned to the borrower if the borrower fails to pay. To collect the whole amount granted, the lender can seize not only the asset for which the loan was granted, but also additional assets of the borrower.read more from a non-recourse loan arises if the borrower defaults and some money remains unrecovered despite the foreclosure of the property. In short, the involvement of collateral security differentiates recourse from non-recourse loans.

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Requirements

One’s eligibility for a non-recourse loan depends on the criteria fulfilled. The borrowers are eligible only if:

  • They satisfy the approval requirements. Normally, borrowers with high credit scores and a low debt-to-income ratio are hardly allowed such loans.
  • The borrowers are ready to pay higher interest rates.
  • They take mortgage finance, which is quite common if they reside in one of the 12 non-recourse states, which include Arizona, Oregon, Texas, Connecticut, California, Alaska, North Carolina, North Dakota, Utah, Minnesota, Idaho, and Washington.

Examples

Let us consider the following instances to understand how the non-recourse loan agreement or arrangement works:

Example 1

Ms. Jolly and Mr. Happy both want to purchase houses individually. They take up loans of $240,000 to be paid within two years, with $10,000 being the monthly installment.

Mr. Happy purchases the house on a recourse loan, i.e., without providing any collateral to the lender and becoming personally liable in case of defaults. On the other hand, Ms. Jolly mortgages the house purchased against the loan taken, making the asset the 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 seizes the houses of both borrowers and recovers $180,000. Still, an amount of $20,000 remains unrecovered.

Now Mr. Happy, who took a recourse loan, has to pay $20,000 through his other assets further, but Ms. Jolly is not personally liable to pay any additional amount. Thus, in the case of a non-recourse loan for real estate, the borrowers remain safe even in the event of default.

Example 2

In October 2023, Park Hotels & Resorts Inc. announced one of its trustees for $725 million non-recourse CMBS loan filing a legal suit against two of its unit in San Francisco. In the appeal, the trustee requested the court to appoint a receiver to recover the loan by selling the properties in question and ensure cessation the loan payment.

The receiver, as appointed, would look after the possessions of the hotels and retain the labor force to run the hotel smoothly. However, the same person would be responsible to sell the unit in case it fails to repay even after the extended period.

Tax Consequences

The tax implications differ based on the type of loan one takes up. The U.S. Internal Revenue Service (IRS) has different taxation guidelines for recourse and non-recourse finances. The authorities consider any loan amount canceled or forgiven as taxable. However, if that canceled or forgiven amount falls under the non-recourse loan category, taxpayers do not possess any tax liabilities.

If a foreclosureForeclosureForeclosure refers to the legal action taken by the lender when the borrower fails to repay the amount due against the mortgage loan. The lender can take the possession of mortgaged asset or property or resale it to a third party for recovering the default loan amount.read more occurs. Lenders sell a house at a cost more than the amount borrowers owe; the latter has to pay taxes on the profits made.

Recourse vs Non-Recourse Loan

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. Hence no personal liability or risk exists for the borrower.

Recourse vs Non-Recourse Loan

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Let us have a quick look at the differences between the two loans:

Recourse LoanNon-Recourse Loan
The lender can seize the collateral and claim additional money from the borrower’s assets if the debt is not settled.The lender is limited to seizing the collateral under a loan contract and cannot further demand more payments.
Lenders can rightfully recover all the duesThe lender’s recovery is limited
The 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 the borrower provides.
High amounts can be offered under recourse loans.The loan amount is limited to the value of the collateral. Generally lower than the value of the collateral.
Due to the personal liability of borrowers, the lender usually offers lower interest rates.The lender tries to charge higher interest rates due to the higher risk of repayment.

Frequently Asked Questions (FAQs)

How to get a non-recourse loan?

To get these loans, one must fulfill the eligibility criteria, which include high credit scores, a steady source of income, and a significantly low loan-to-value (LTV) ratio. 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. In addition, as a borrower tries to find a property that stands on its cash flow, the cash flow from the property should not be less than 1.25 times the amount of the proposed payment to be made on loan.

Are SBA loans non-recourse?

The SBA loans, which help small businesses, do not offer recourse loan options. However, they do have non-recourse finances that secure amounts for fixed assets, like real estate, etc.

Is a reverse mortgage a non-recourse loan?

Yes, a reverse mortgage falls under the non-recourse finance option. Such loan options do not allow borrowers to owe more than the value of their house at the time of maturity.

Recommended Articles

This has been a guide to What is Non-Recourse Loan & its definition. We explain how it works with an example, its taxation, & comparison with a recourse loan. You can learn more about Corporate Finance from the following articles –

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