What Is Limited Recourse Debt?
Limited recourse debt is a type of debt that gives the creditor a claim on some but not all of a borrower's assets if they default on a loan. It sits between full recourse debt and non-recourse debt in terms of the creditor's ability to seize any of the borrower's assets beyond the collateral backing the loan. Limited recourse debt is also referred to as partial recourse debt.
Key Takeaways
- Limited recourse debt is debt, such as a loan, that gives the creditor the legal right to certain, but not all, of the borrower's assets if the borrower defaults.
- Full recourse debt allows creditors to claim any and all of the borrower's assets to fully cover the unpaid portion of a loan.
- Non-recourse debt means the creditor can claim only the collateral put up for the loan and nothing else.
How Limited Recourse Debt Works
In the world of lending, the word "recourse" refers to a creditor's legal right to collect the money they are owed by a borrower if the borrower defaults on a debt.
In a non-recourse loan, if a borrower defaults on their payments, the creditor can seize the collateral the borrower put up for the loan but not go after their other assets.
In a full recourse loan (sometimes simply referred to as a recourse loan), the creditor can go after any of the borrower's other assets if the collateral is insufficient to pay off the debt. With a full recourse auto loan, for example, if the vehicle isn't worth enough to pay off the loan in full, the lender could take legal action to levy the borrower's bank account (withdraw money from it) or garnish their wages, among other remedies.
With a limited recourse loan, the lender can also seize the borrower's collateral, but it can only go after other assets that are specifically listed in the loan contract. Any assets beyond that are off limits, and the borrower is not personally liable for any shortfall.
Pros and Cons of Limited Recourse Debt
From a borrower's point of view, limited recourse debt is better than full recourse debt, because it can protect at least a portion of their assets from seizure by a creditor. At the same time, it is not as good as non-recourse debt, where only their collateral is at risk.
From a lender's perspective, it's just the opposite. Full recourse debt is better for the lender's purposes because it gives them greater assurance that they'll be able to recover the money they are owed—or at least more of it than they could recoup through either limited or non-recourse debt.
For that reason, lenders are more likely to offer full recourse loans than the other two types. If they do offer either limited recourse or non-recourse loans, they are likely to charge a higher rate of interest on them in order to make up for the added risk.
Example of Limited Recourse Debt
Limited recourse loans are rare in the world of consumer lending but may be found in commercial lending, particularly for large real estate projects.
For example, a developer might try to obtain a limited recourse loan in order to finance a new housing development. In addition to the development itself, which would likely serve as collateral, the developer could agree to make some of its other assets available for seizure by the lender in the event of default. That could allow it to obtain a better interest rate than it would with a non-recourse loan (if it could even get one), while also protecting certain of its assets, such as other housing developments that it has in progress.
What Is Secured vs. Unsecured Debt?
Secured debt refers to a loan that is backed by collateral put up by the borrower, while unsecured debt involves no collateral. Auto loans are an example of secured debt, with the car itself generally serving as collateral. Most credit cards, on the other hand (with the exception of secured credit cards), are unsecured debt. Limited recourse debt, full recourse debt, and non-recourse debt are different forms of secured debt.
What Is Foreclosure?
Foreclosure is the process through which lenders take possession of a mortgaged property, such as a home, if the borrower has defaulted on their loan. The lender can then sell the property in order to recoup at least some of the money it is owed. In mortgage lending the home itself usually serves as collateral for the loan.
What Is Repossession?
Repossession refers to the seizure of a debtor's collateral if they default on a loan. It is typically referred to in connection with auto loans, for which the vehicle serves as collateral. But other items bought on credit can also be repossessed, such as furniture or appliances. Repossession can be either voluntary (in which the debtor will surrender the collateral) or involuntary (in which a debt collector will seize it on behalf of the creditor).
What Can Serve as Collateral for a Loan?
Generally speaking, anything of value can serve as collateral for a loan if the lender is willing to accept it. In the case of consumer loans, homes often serve as collateral for mortgages and home equity loans, while cars serve as collateral for car loans. But cash, securities, life insurance, jewelry, art collections, and other valuables can also be used. For commercial loans, a business might put up real estate, equipment, inventory, or trademarks it owns, to name a few examples.
One thing that generally can't serve as collateral is the money in an individual's retirement account, such as a 401(k) plan. That's due to Internal Revenue Service rules. However, the account holder may be able to take a loan from the plan if their employer permits it.
The Bottom Line
Limited recourse debt can be advantageous to a borrower if they don't want to put everything they own at risk. It is less attractive to lenders than full recourse debt, so they may not offer it or may charge the borrower more for it.
