What is Recourse Loan?
Recourse Loan is a type of loan where the lender has got the right to extract the full amount of money lent to the borrower wherein if the borrower fails to pay, then the lender can seize the not only the asset for which the loan was taken but also, the confiscate other assets of the borrower to recover the full amount that he has lent.
Whenever any borrower asks for a loan, the first thing that is checked is whether the lender will get his money back. Recourse Loan is a special legal safety given to lenders to protect their money. The money that the lender provides to the borrower is actually an investment for the lender.
So the government in order to safeguard investments of lenders, provide steps to recover entire money of lender from the borrower. So such loans are protected loans for lenders, which helps them to recover the entire loan money, even if the mortgaged asset failed to cover it up in full.
Examples of Recourse Loan
Mr. Albert is planning to start a new business in catering. His estimation of cost is $50,000. He is not employed and has never taken any loan earlier. Considering his current scenario it will be difficult for Mr. Albert to get a loan from any bank as they look for creditworthiness. As he has never taken any loan earlier so he doesn’t have a Credit score, which makes it even harder for him to get a loan.
So now if he is getting a loan from a person or loan agency which states that they will be giving loan but with a clause that the loan will be recourse. So knowing the fact that recourse loans are riskier than normal mortgage loans where the liabilities are restricted, he will still go for it as he really needs money to do the business. So if now Mr. Albert fails to make payment then the lender has got the right to drag Albert to court and sell any or all of his assets to recover his money.
Example #2 – Full Recourse or Partial Recourse
Mr. X applied for a loan of $10,000 with full recourse terms from Thomas and also applied for another loan of $20,000 with a partial Recourse scheme (80%) from David. Now if Mr. X fails to pay both the loans, then Thomas will be able to recover his full money by selling assets of Mr. X in full, but David will also be able to recover his money till the extent of 80% of $20,000.
Influence of Recourse on the Borrowers
Any recourse loan is risky for the borrowers. It creates extra liability on a borrower to pay the amount in full in case the mortgaged asset falls short. Borrowers who are actually in need of money and have got intentions to pay back the money in full shouldn’t be worried about the recourse clause. Such loans are easy to get as it is safe for the lender and they have the advantage of claiming any asset they want.
Recourse vs Non-Recourse loan
Recourse Loan is a type of loan where the lender has got the right to claim the full money back in case the borrower fails to pay back the money. In Non-Recourse, the lender has got the right to sell of the asset that the borrower kept as mortgaged.
Say a borrower borrowed $10,000 and the asset that he kept was of value $7,000. If the loan is Non-Recourse then the lender can recover only $7,000 from selling the asset and the rest $3,000 will be gain for borrower and loss for the lender. If the loan would have been a Recourse loan then the lender would have sold out the asset and other assets of the borrowers until and unless the loan is recovered in full.
- Borrowers who don’t have all the proper paper works can still get a loan as the loan is safe to the lenders and they are ready to lend without all proper documents
- Recourse Loans help in the proper flowing of money in the economy. As the Loan is safer than Non-Recourse, so many new lenders are ready to invest their money in the economy which is helping small businesses to flourish and the economy is getting strong
- In recourse loans, borrowers are charged a much higher rate than regular banks. It also makes it difficult for the borrower to pay the loan in full along with the high interest charged
- At times lenders know that a borrower will not be able to pay back but still, they give loans because they know that the asset values are more which they want to confiscate.
- When a borrower fails to pay a loan, it means that he doesn’t have money. It that situation if lenders start to sell off their remaining assets then it gets really difficult for the borrower to cope with it psychologically.
Recourse Loans are very popular in the economy and is helping small businesses to flourish. As a society, we should all have good ethics which will help us to grow together. It is the responsibility of the borrower to pay back the entire money borrowed, it is also necessary for lenders to think the state of the borrower is in.
If the borrower is really not being able to pay the loan due to his poor financial condition, then it’s better to wave off part of the loan or the loan in full.
This has been a guide to what is recourse loan and it’s meaning. Here we discuss the influences and examples of recourse on borrower along with advantages and disadvantages. You can learn more about accounting and financing from the following articles –