Recourse loans vs. Non-recourse loans – Forbes Advisor

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Recourse loans are a type of secured debt that allows lenders to recover overdue loan balances by foreclosing both the loan collateral and, if necessary, the borrower’s other assets. Common types of recourse debt are auto loans, credit cards, and in most states, residential mortgages.

In the event of default, the lender can seize and sell the collateral. If this collateral is not sufficient to cover the outstanding loan balance, then the lender can take on the borrower’s other assets. Recourse loans pose less risk to lenders, so they generally have lower interest rates and are more widely available.

Non-recourse debt is also secured by a guarantee from the borrower. However, in the event of default, the lender can only seize the collateral specified in the loan documents and cannot go after other assets of the borrower. Few banks offer non-recourse loans, but home loans are treated as non-recourse loans in 12 non-recourse states. Non-recourse debt also has higher interest rates and more restrictive borrowing terms than recourse, because non-recourse debt is riskier for lenders.

What is a recourse loan?

With recourse loans, the borrower is personally responsible for 100% of the loan amount. Therefore, the lender can first repossess or seize the collateral for the loan as specified in the loan agreement. If the lender is not able to recover the entire loan balance by selling this collateral, they can get a judgment in default from the courts and attack the borrower’s other assets. This is the case even for assets that have not been identified as the underlying collateral for the loan and may include wage garnishment or the withdrawal of bank accounts to repay remaining debt.

Credit card, auto loans, and hard money loans (usually short-term home loans offered by non-bank lenders) are common types of recourse loans. In the event of default, the lender can repossess the vehicle or items purchased with the loan (collateral) and sell them to recover the outstanding loan balance. In many cases, the collateral will have already been impaired or destroyed and the lender will need to obtain an insufficiency judgment for the difference in value. The lender can then attempt to get his money back by seizing the borrower’s other assets.

In all but 12 states, home mortgages are also considered recourse loans. If a borrower is underwater on their mortgage, which means that the outstanding debt is greater than the home’s value, the bank may not be able to get all of their money back from a foreclosure sale. In this case, the bank can get a deficiency judgment for the difference between the debt and the foreclosure selling price and then garnish the borrower’s salary or drop a privilege against other assets.

Even if a lender obtains a judgment against a borrower, collecting outstanding debt can be costly and time consuming. If a lender believes that the borrower does not have substantial assets to operate, they may never collect the outstanding debt. However, you should always try to avoid this outcome by contacting your lender if you think you might default.

Example of a loan with recourse

If a borrower takes out a $ 20,000 auto loan to buy a $ 25,000 car, the debt will be secured by the vehicle. If, after several payments, he defaults on the loan with $ 16,000 remaining on the loan, the lender can repossess the car and sell it to recover the outstanding loan balance. However, if the car has depreciated and can only be sold for $ 12,000, the lender can also get an insufficiency judgment from a court and then garnish the borrower’s salary to recover the remaining $ 4,000. .

What is a non-recourse loan?

A non-recourse loan is a loan where, in the event of default, a lender can seize the collateral for the loan. However, unlike a recourse loan, the lender cannot prey on the borrower’s other assets, even if the market value of the collateral is less than the outstanding debt. Even though lenders are limited in their ability to obtain a judgment of insufficiency, non-recourse loans still create some personal liability, as the lender can seize the collateral for the underlying loan.

Even so, lenders who provide non-recourse loans are at greater risk of not getting back the loan balance and interest payments. For this reason, non-recourse loans are not offered by most financial institutions, but some banks, online lenders, and private lenders will extend this type of debt.

Mortgage loans, while generally non-recourse, are non-recourse in 12 states: Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah, and Washington. If a homeowner defaults in one of these states, the lender can foreclose on the collateralized home but cannot take out the borrower’s other assets.

Example of a non-recourse loan

Consider the example of a buyer who takes out a mortgage for $ 250,000 to purchase a house with an appraised value of $ 300,000. If the homeowner does not repay the $ 230,000 of the loan, the bank can foreclose on the secured property in an attempt to collect the outstanding debt. However, in some states, if the local real estate market is inundated with inventory and the home can only be sold for $ 215,000, the lender cannot recover the additional $ 15,000 through garnishment. salary or other means.

Loan of recourse. Non-recourse loan: which is better?

Regardless of whether a secured loan is recourse or non-recourse, the lender can seize the borrower’s collateral in the event of default. The main difference is that with a non-recourse loan, the lender can only grab the specific collateral, even if it is worth less than the outstanding debt. With a recourse loan, however, the lender can seize the secured assets of the borrower and, if he cannot recover the outstanding loan balance by selling that collateral, then may prey on the other assets of the borrower. borrower.

The best loan option depends on the borrower’s needs, creditworthiness, and confidence in their ability to make payments on time. You are likely to get a recourse loan if you:

  • You have a poor credit history or a high debt-to-income ratio. In addition to lower interest rates, recourse loans also have more lenient loan approval requirements. If your credit rating is low or your debt-to-income ratio is high, which means that a significant percentage of your income is spent on debt service each month, you are more likely to get a recourse loan.
  • You want a lower interest rate. Recourse loans are not as risky for lenders as non-recourse loans because lenders have more flexibility when collecting their debt in the event of default. For this reason, lenders can offer more competitive interest rates on recourse loans than they can on non-recourse loans.
  • You take out a car loan or a credit card. Certain types of debt, such as credit cards and auto loans, are generally structured as recourse debt. For this reason, borrowers must agree to recourse loan terms if they are to take advantage of many traditional financing options.

Non-recourse loans may be an option if you:

  • May meet more stringent approval requirements. In rare cases, borrowers with a high credit rating and low debt-to-income ratio can get a loan without recourse.
  • Are willing to pay a higher rate of interest. Likewise, a higher interest rate protects lenders who are exposed to riskier non-recourse loans.
  • take out a non-recourse mortgage loan. If you are in one of the 12 non-recourse states, you will automatically get a non-recourse mortgage.

How to determine your type of loan

Generally speaking, it doesn’t matter whether your loan is recourse or non-recourse, unless you are behind on your loan repayments. However, if you want to know if your current mortgage is recourse or non-recourse, start by determining if you are in a state of recourse as stated above.

If you have any other type of debt, such as a car loan or credit cards, you can determine your loan type by reviewing your original loan documents or by contacting your lender directly. If you confirm that you have a recourse loan and think you might default, talk to your lender about options to avoid default, such as abstention or loan modification. You should also work with your lawyer or accountant to assess the implications of default, foreclosure, and possible wage garnishment.

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