What Are Recourse Loans and Non-Recourse Loans? (2024)

What Are Recourse Loans and Non-Recourse Loans? (1)

Recourse loans and non-recourse loans are both fairly common in thecommercial real estate world. If you’re in the business, you need to have a good idea of what each one is and how it works. Here’s a quick rundown of these two types of commercial real estate loans.

What Are Recourse Loans?

Recourse means “the legal right to demand compensation or payment.”

With a recourse loan, if the borrower defaults on the loan, the borrower or guarantors are personally liable. This means they are responsible for repaying the outstanding balance and handing over any collateral in a default situation. Additionally, the lender can seek financial damages as well if the situation calls for it. So, for example, if the borrower needs to liquidate the collateral but the resulting money doesn’t cover the amount owed on the loan, the borrower and guarantors are still on the hook for the difference. The lender can pursue them personally to cover the total amount owed. This is where the assets on the personal income statement come into play.

In the world of recourse loans, there’s greater flexibility in the process, pricing, and overall structure of the loan.

What Are Non-Recourse Loans?

As you may have guessed, a non-recourse loan is just the opposite of a recourse loan. It’s often seen as an alternative financing option. With non-recourse loans, the borrower or guarantors aren’t personally liable for repaying the outstanding balance and collateral on the loan if they default. The lender can seize the assets that were labeled as collateral in the transaction. However, the lender cannot go after the borrower or guarantor personally. Generally, only people or businesses who have excellent credit are candidates for non-recourse loans. And, these are longer-term loans, with larger capital expenditures, and slightly higher interest rates. The longer-term loan allows a property owner to maximize their cash flow while reducing their risk profile.

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With non-recourse loans, the lender has the potential to lose money. However, even when a non-recourse loan is used, there are situations where the borrower/guarantor can be held personally liable—we’ll get to those later.In any event, if a default occurs, it will still impact the borrower’s credit score.

When Are Recourse or Non-Recourse Loans Used?

Recourse financing is preferred by most lenders, and recourse loans are usually used for any transaction that might potentially be risky. Since the lender is legally able to seize property beyond the initial underlying asset, it can reduce the perceived risk.

Non-recourse loans come in two forms. The first and less common is balance sheet lending where the loan stays in-house. These loans are usually used for smaller amounts. The second and more commonly accepted non-recourse loan is along-term permanent commercial real estate loans that are placed on a stabilized and performing asset. Not every borrower is able to get a non-recourse loan. This is a place where experience and a good track record counts. Once an asset is stabilized, a non-recourse loan is an excellent option.

What Are Carve-Out Provisions/Bad Boy Guarantees?

Not every borrower is trustworthy. That’s why there are provisions to protect the lender in the case of fraud. A carve-out provision, or “bad boy guaranty/guarantee,” makes an exception to non-recourse loans.

So, if a borrower files for bankruptcy, doesn’t maintain the required insurance, doesn’t pay their property taxes, gets accused of fraud, or commits another crime, then the lender may be able to pursue personal recourse. In some cases, there doesn’t even have to be a major event—there are minor provisions that may be acceptable.

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What’s the Current Status of Recourse and Non-Recourse Financing?

Recourse loans are the more traditional option, and it is likely that they will always be more prevalent. They certainly aren’t going anywhere anytime soon.

However, commercial real estate owners are becoming aware that they can reap the benefits of non-recourse loans. Since non-recourse loans are less risky for borrowers, they are in high demand among those who know about them. And, lenders are sometimes willing to extend non-recourse because it gets them a higher yield on their money.

Lately, these loans have been popular with fix-and-flip real estate investors. Recent high-profile non-recourse loans include these $100 million loans by Ready Capital and this $75 million non-recourse loan on a Texas retail property.

Depending on your commercial real estate situation, you might consider pursuing a non-recourse loan the next time you’re in the position of financing a property.


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What Are Recourse Loans and Non-Recourse Loans? (6)

Article Name

What Are Recourse Loans and Non-Recourse Loans

Description

Learn the basic definition, responsible parties, and applications for both non-recourse loans and recourse loans for when you are financing your next commercial real estate property.

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Jeri Frank

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STRATAFOLIO

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What Are Recourse Loans and Non-Recourse Loans? (7)

What Are Recourse Loans and Non-Recourse Loans? (2024)

FAQs

What Are Recourse Loans and Non-Recourse Loans? ›

Like recourse loans, a non-recourse loan is secured with collateral in case of default. The main difference is that the lender has no additional recourse after seizing collateral, even if the amount doesn't cover the outstanding balance.

What is a recourse and non-recourse loan? ›

There are two types of debts: recourse and nonrecourse. A recourse debt holds the borrower personally liable. All other debt is considered nonrecourse. In general, recourse debt (loans) allows lenders to collect what is owed for the debt even after they've taken collateral (home, credit cards).

What is an example of recourse debt? ›

Credit cards, auto loans and hard money loans—typically short-term real estate loans offered by non-bank lenders—are common types of recourse loans. In the case of default, the lender can repossess the vehicle or items purchased with the loan (collateral) and sell them to recoup the outstanding loan balance.

Are most mortgages recourse or nonrecourse? ›

Personal loans, auto loans, credit cards and short-term real estate loans are all considered recourse loans. Most mortgages are also recourse loans.

What are the benefits of a recourse loan? ›

The main advantage of recourse loans is that they typically offer lower interest rates and can provide the lender with more comfort with the deal at hand. However, the downside is that they can be risky for borrowers because they are personally liable for the loan.

What is a recourse loan? ›

A recourse loan allows the lender to seize the collateral and any other assets the borrower has if they default. Assets that a lender may seize for a recourse loan include deposit accounts and income sources. Resource loan contracts generally outline which assets the lender may pursue.

What is the difference between recourse and non-recourse factoring? ›

Recourse factoring is the most common and means that your company must buy back any invoices that the factoring company is unable to collect payment on. You are ultimately responsible for any non-payment. Non-recourse factoring means the factoring company assumes most of the risk of non-payment by your customers.

Which of the following is an example of nonrecourse debt? ›

A non-recourse loan is secured only by the listed collateral. A mortgage is a good example. If you default on your mortgage, the bank can seize the house to recoup their investments, but they can't seize your car or bank accounts.

What are the risks of recourse debt? ›

Recourse loans place the majority of the risk and exposure on the borrower. If the borrower defaults, the lender may seize the property covered by the loan AND go after the borrower's other assets and financial accounts to recover any additional debt.

What are the 12 non-recourse states? ›

There are 12 states that, by law, only allow nonrecourse loans. These are known as “nonrecourse states,” and they include Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah and Washington.

What are the disadvantages of a non-recourse loan? ›

The main disadvantages of a non-recourse loan are tied to the loan terms a borrower can receive. Because the risks to a lender are higher than with recourse debt, a lender will typically pass this on in the form of higher interest rates, or lower loan amounts relative to the property value to offset the risk.

Is non-recourse debt at risk? ›

Generally nonrecourse loans are not considered at risk for purposes of the at-risk limitations. An important exception applies to qualified nonrecourse financing that is secured by real property used in the activity of holding real property.

Is a non-recourse loan secured? ›

Nonrecourse debt or a nonrecourse loan (sometimes hyphenated as non-recourse) is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable.

Do you have to pay taxes on a non-recourse loan? ›

But in a nonrecourse situation where your lender cancels the remaining debt, you won't have to pay taxes on it. One other tax implication to note: If you're dealing with a foreclosure and your lender sells your home for more than you owe, you might still owe tax on any gain from the sale.

What states are non-recourse? ›

The 12 Non-Recourse States
  • Alaska.
  • Arizona.
  • California.
  • Connecticut.
  • Idaho.
  • Minnesota.
  • North Carolina.
  • North Dakota.

Is an FHA loan a non-recourse loan? ›

The benefit to the lender is that the loan is insured by FHA. The benefit to the borrower is that the loan is at a fixed interest rate, often lower than conventional rates, and is non-recourse.

What are the benefits of a non-recourse loan? ›

The primary benefit of non-recourse loans is that they provide a greater degree of protection for the borrower. Without a personal guarantee, the lender cannot seize the borrower's personal assets if they default on the loan.

What are the risks of non-recourse financing? ›

If the property happens to decline in value, or if there are major fundamental issues with the property, it becomes the burden of the lender, often as a loss to them. For example, if an individual takes out a non-recourse mortgage on a home and defaults on the payment, the lender can seize the home.

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