When borrowing money, it’s important to understand your obligations for paying it back and what can happen if you default. Specifically, it’s necessary to know the difference between recourse vs. nonrecourse loans.
Whether a debt is considered recourse or nonrecourse can vary from state to state and the type of debt involved. Before borrowing money, it’s helpful to know more about what distinguishes nonrecourse financing from other types of loans.
What Is a Recourse Loan?
A recourse loan is a secured loan for which the lender can seize more than just the collateral if the borrower defaults. The lender is also able to seize other assets the borrower didn’t use as collateral, including income and money in bank accounts.
How Recourse Loans Work
When a borrower defaults on a recourse debt, the lender can seize not only the loan’s collateral, but can also attempt to attach other assets to collect what’s owed. In essence, the lender has additional recourse to recoup their losses.
Between recourse vs. nonrecourse debt, recourse debt favors the lender while nonrecourse debt favors the borrower.
Examples of Recourse Loans
Hard money loans, which are typically based on the value of the collateral rather than just the creditworthiness of the borrower, tend to be recourse loans.
An auto loan is one example of a recourse loan. If an auto loan borrower defaults on the loan, the lender has the right to seize the vehicle and sell it to recoup its losses. If the vehicle has depreciated, however, and the sale doesn’t cover the loan balance, the lender can ask for a deficiency judgment for the difference. In that case, the borrower’s wages could be garnished or the lender could seize other assets.
What Is a Nonrecourse Loan?
A nonrecourse loan is a secured loan for which the lender cannot seize assets that weren’t put up as collateral in the original loan agreement.
How Nonrecourse Loans Work
When a borrower pledges collateral on a secured loan, the lender can take that asset — but no others — if the borrower defaults on the loan. The lender will typically sell the asset to recoup their loss on the loan. The lender has no other recourse than seizing the collateralized asset, even if the sale of that asset doesn’t cover the balance of the loan.
Examples of Nonrecourse Loans
Lenders may be cautious about offering nonrecourse loans because it limits their ability to recoup losses in the event of a default. Therefore, loans are typically classified as recourse loans.
Mortgages are classified as nonrecourse debt as a matter of law in 12 states meaning the lender cannot pursue a borrower’s other assets if they default and end up in foreclosure. The financial consequences would likely be limited to loss of the home and damage to the borrower’s credit score.
A lender might be willing to offer a nonrecourse loan to an applicant with excellent credit and steady, verifiable income if confident in their ability to repay the debt.
Recourse vs Nonrecourse Loans
Both recourse and nonrecourse debt can be secured by collateral, which a lender can seize in the event of nonpayment.
The biggest difference between the two is that the lender is prevented from pursuing other assets owned by the borrower to repay what’s owed on a nonrecourse debt. Basically, the lender has no other recourse for repayment of the debt other than the collateral that secures the loan.
|Lender can seize assets other than those put up as collateral.
|Lender can seize only assets that were put up as collateral.
|Borrower can lose collateralized and other assets if they default.
|Borrower can lose collateralized asset and have a negative entry on their credit report if they default.
|Loan rate and terms are based on the value of asset used as collateral and creditworthiness of applicant.
|Lender may consider creditworthiness of applicant greater than value of collateral when determining loan rate and terms.
|Less risky for lenders.
|Less risky for borrowers.
Pros and Cons of Recourse vs Nonrecourse Debt
Depending on whose perspective the situation is being viewed from, recourse and nonrecourse debt each has benefits and drawbacks.
Pros and Cons of Recourse Loans
Recourse debt is more favorable to the lender than the borrower because this type of debt gives the lender more avenues to collect when a debt goes unpaid.
Approval for recourse loans, on the other hand, may be easier since they pose less risk for lenders.
From the borrower’s perspective, here are some pros and cons of recourse loans:
|Pros of Recourse Loans
|Cons of Recourse Loans
|Approval qualifications may be less stringent than for a nonrecourse loan.
|Lender can seize collateralized asset and other assets if the borrower defaults.
|Interest rates can potentially be low.
|Borrower assumes greater risk than lender.
Pros and Cons of Nonrecourse Loans
A nonrecourse loan is more favorable to the borrower in the case of default. In that situation, the lender could only seize the asset put up as collateral, but couldn’t lay claim to any of the borrower’s other assets.
Nonrecourse financing is usually riskier for the lender since they’re limited to collecting only the collateral when a borrower defaults. As such, lenders may charge higher interest rates for nonrecourse loans and/or require borrowers to meet higher credit scores and income requirements to qualify.
From the borrower’s perspective, here are some pros and cons of nonrecourse loans:
|Pros of Nonrecourse Loans
|Cons of Nonrecourse Loans
|Only the asset put up as collateral can be seized if the loan is defaulted on.
|Borrower’s credit can be negatively affected if the lender must write off uncollected debt.
|Personal assets are not at risk.
|Interest rates may be high.
Managing Recourse vs Nonrecourse Loans
Generally, the only reason for a borrower to be concerned about whether they have recourse vs. nonrecourse debt is if they’re in danger of default. As long as they’re keeping up with their payments, whether a debt is recourse or nonrecourse shouldn’t be an issue.
But if there is a concern about potentially falling behind in paying a debt, then it helps to do some research before borrowing. For example, if trying to qualify for a home loan, asking upfront whether the loan is treated as recourse or nonrecourse debt under a particular state’s laws will help in the decision making.
Making a larger down payment, for example, means less a borrower has to finance. Ultimately, though, a borrower should do what is right for their particular financial situation. It may be better for some borrowers to choose a home loan that allows for a lower down payment so they can keep more cash in the bank to cover financial emergencies down the line.
If planning to apply for a car loan, a person may consider buying a vehicle that tends to hold its value longer or making a larger down payment. Those could both help a borrower avoid ending up underwater on the loan if they happen to default for any reason.
Credit cards are revolving debt, not a lump sum being borrowed, so the amount owed can change month to month as purchases are made and paid off. Some ways to manage this type of recourse debt include:
• Keeping card balances low.
• Paying the balance in full each month, if possible.
• Setting up automatic payments or payment alerts as notification of when a due date is approaching.
With any type of debt, recourse, or nonrecourse, it’s important that the borrower gets in touch with the lender or creditor as soon as they think they’ll have trouble making payments. The lender may be able to offer options to help manage payments temporarily. Depending on the type of debt, that may include:
• Credit card hardship programs.
• Student loan forbearance or deferment.
• Skipping or deferring auto loan payments.
Reaching out before a payment is missed can help avoid loss of assets and it can help prevent negative credit score impacts as well.
Is a Recourse or a Nonrecourse Loan Best for You?
It’s likely you won’t have much of a choice between a recourse and a nonrecourse loan when looking at financing options. Lenders are likely to offer only recourse loans because they have more options to recover losses if the borrower defaults on the loan.
If you are presented with both options, choosing a recourse or nonrecourse loan may depend on your financial situation.
• A recourse loan may be a good option for those with a limited credit history because in exchange for additional avenues to recoup their losses, if necessary, a lender may offer low interest rates.
• A nonrecourse loan could be a good option for an applicant with good credit and steady income, as the lender may consider them a low-risk borrower and not feel the need to have additional assets to secure the loan.
SoFi Personal Loans Rates
If you’re looking for a way to manage multiple debts, consolidating them can help streamline your monthly payments and possibly help you pay down your debt faster or at a lower interest rate.
SoFi Personal Loans are unsecured, so no collateral needed, and can be used for debt consolidation. Checking your rates takes just one minute, with no commitment.
Since interest rates are fixed, your monthly payments are predictable.
What does recourse mean in lending?
Recourse refers to a lender’s options when recouping losses when a borrower defaults on a loan.
Are you required to pay a nonrecourse loan?
Yes, borrowers are required to make payments on both recourse and nonrecourse loans.
Are nonrecourse loans more expensive?
Nonrecourse loans can have higher interest rates than recourse loans because lenders may perceive them as having higher risk.
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