What is a Recourse Loan (Debt)?
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 collateral (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.
- 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) – 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, mortgages 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 estate.
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.
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