Recourse Debt

Recourse Debt Meaning

Recourse Debt is one of the types of loans which is less risky for a lender for investment, as having this loan gives the lender a right to recover its investment using the collateral asset if the borrower is unable to make its promise payment or outstanding liability which is specified into a loan agreement. Also if the current market value of the borrower’s collateral underlying assetsUnderlying AssetsUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates.read more is not enough to recover outstanding loan then as per the recourse agreement lender can claim for other assets of the borrower which were not initially used as collateral.

Recourse Debt Example

The loan agreement will specify whether the loan is recourse or non-recourse.

Mr. Brian Pinto is a United States resident and recently got a stable job in a pharmaceutical company which gets him a monthly paycheck of $8,000. Mr. Pinto planning for buying a house in New York City for $250,000. Mr. Pinto has a saving of $50,000, So he went to a financial institution to look what are options available for him to obtain the loan of remaining amount $200,000 for his house financing, and also his credit records are not enough for this loan.

So after understating the scenario bank manager offered a recourse debt to Mr. Pinto which specified that under loan agreement the financed home will be kept as collateral and taking some percentage of his paycheck directly as a monthly installment payment. Since he had no other option available to get a loan, he accepted the offer from the financial institution.

Recourse Debt

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For eg:
Source: Recourse Debt (wallstreetmojo.com)

What if Mr Pinto Stop Making Payment?

As mentioned above, home financing is a recourse debt and specified in the loan agreement.

Options to Recover Money for Recourse Debt
Options to Recover Money for Non-Recourse Debt

(if the above-mentioned debt is financed under Non-recourse)

Non-recourse debt is secured by collateral assets. The only difference here is if Mr. Pinto defaults on the loan payment then the lender can only claim to the collateral asset which was pledged initially in the loan agreement and lender cannot seek any further compensation even if collateral assets are not sufficient to recover outstanding loan balance. For the lender, it is riskier to give non-recourse to a less creditworthy borrower but if they do, the lender charges high interest on the loan to compensate the risk associated with the loan.

In the Non-recourse debt, sometimes the borrower purposely defaults on the loan payment when the total outstanding loan balance is greater than the value of the assets pledged as collateral. This is also known as Strategic Default by borrowers.

Advantages of Recourse Debt

Some of the advantages of recourse debt are as follows:

Disadvantages of Recourse Debt

Some of the disadvantages of recourse debt are as follows:

Important Point to Remember

  • It is important to understand the terms of the loan initially.
  • Recourse debts favor the lender.
  • Non-recourse debt favors the borrower.
  • For the good creditworthy borrower, a recourse can be beneficial as he can enjoy a low-interest rate on the loan.

Conclusion

When an individual or small business looking for the loan, usually there are two types of loans are available i.e. Recourse and non-recourse debt and the primary difference between these two types is whether or not the borrower’s personal liability for the loan payment. Under the recourse agreement, the lender can go after the borrower’s personal assets if pledged collateral is not enough to recover the outstanding loan balance. Wherein under the non-recourse, a lender can claim only to the collateral pledged initially if the borrower’s default on the loan payment.

This has been a guide to recourse debt and its meaning. Here we discuss the options available to recover money from recourse and non-recourse debt with examples. You can learn more about Corporate Finance from the following articles –

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