Lending money involves significant amounts of risk on behalf of the lender. To help minimize risk, lenders typically set strict requirements to get the best interest rates on loans. However, lenders may go even further to reduce risk by offering recourse loans.
What Is a Recourse Loan?
When you sign a contract for a loan, there are generally details that specify what actions a lender may take should you default on the loan. Recourse loans are loans that allow a lender to seize additional assets of a borrower who defaults if the debt balance surpasses the value of the collateral. Recourse loans can be attractive to borrowers, as they generally have lower interest rates.
Here are some common types of recourse loans:
- Personal loans
- Credit cards
- Short-term real estate loans
- Auto loans
- Mortgages (government-back mortgages are non-recourse)
How Does a Recourse Loan Work?
With a recourse loan, the borrower is 100% liable to repay the debt amount. Defaulting on a recourse loan gives the lender every right to levy bank accounts or garnish wages to collect what’s owed.
Let’s say a small business owner takes out a $650,000 recourse loan to purchase a property for business operations. Five years later, the owner tries to sell the property, but the building is only worth $575,000 because of a decline in the market. Because of this, the lender can go after property, such as the owner’s home and bank accounts, to recoup the additional $75,000 owed.
Recourse Loan Vs. Non-Recourse Loan
A recourse loan allows a lender to seize any asset to recoup the debt that is owed. A non-recourse loan only allows the lender to seize the asset associated with the loan. Recourse loans are more popular with lenders as they minimize risk; however, they can be high risk for borrowers.
Recourse Loans Pros & Cons
For a borrower, recourse loans have several advantages and one considerably large disadvantage.
- Lower credit score requirements: Because the lender can go after collateral and other assets should the borrower default on the loan, it’s generally easier for borrowers with lower credit scores to get approved for a recourse loan.
- Lower interest rate: There are usually lower interest rates for recourse loans than for non-recourse loans.
- Easier approval process: The underwriting and approval process for recourse loans can be easier to navigate because they carry less risk for lenders.
Recourse loans carry significant risks for borrowers. Not only can the lender seize the collateral backed by the loan, but the lender can also go after additional assets to recoup any remaining debt that you owe.
Should I Consider a Recourse Loan?
Before taking out a recourse loan, you need to weigh the pros and cons. Make sure to check your state’s laws and the lender’s contract terms to determine when a loan is in default.
If you already have a recourse loan, your best option is to pay your bills on time. However, if you’re worried about defaulting on your loan, speak with your lender to go over your options.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.