What Is a Non-Recourse Loan?

If you’ve ever had an auto loan or mortgage, you may be familiar with a secured loan, a type of loan that is backed by collateral, which is something of value you possess, like a car.

But a non-recourse loan doesn’t work quite like most other secured loans, and it isn’t as common. Let’s explore what sets non-recourse loans apart from other loans, how they work and when they’re used.

How does a non-recourse loan work?

A non-recourse loan is a type of secured loan that limits what lenders can collect if the borrower is unable to pay. A non-recourse loan does not allow lenders to collect anything other than the collateral when attempting to collect a debt. For example, if a borrower defaults on a non-recourse home loan, the lender cannot pursue any additional legal action after foreclosure. In general, the lender cannot take further legal action to collect any other money owed on the debt.¹

Unlike other secured loans which allow lenders to take possession of collateral and other assets to recoup their losses, non-recourse loans only let lenders take the collateral associated with the loan.

Let’s look at another example. Say a company has a 10-year non-recourse commercial mortgage. If the company stops making payments after three years and leaves a $250,000 balance, the lender may foreclose the property. However, even if the property only sells for $200,000, the lender can’t legally pursue any of the company’s other assets to recoup the remaining $50,000.

Non-recourse loans generally feature high loan amounts, long repayment terms and limited ability for the lender to recoup losses. These factors make non-recourse loans less risky for borrowers but riskier for lenders, so many don’t offer them. To offset risk, lenders may require applicants to have a higher credit score or make a significant down payment, and they may charge higher interest rates.²

If a borrower defaults on a non-recourse loan, there are still potential consequences. For example, defaulting on a non-recourse loan would likely negatively affect the borrower’s credit score and their ability to take out new loans and lines of credit in the future.

Types of non-recourse loans

Non-recourse loans are uncommon. When you do encounter a non-recourse loan, it will have different terms and conditions than a traditional loan. Some kinds of non-recourse loans may include:

• Some mortgages: In some U.S. states, there are laws that allow non-recourse residential mortgages under certain circumstances.³
• Some commercial real estate loans: A developer or other business might use a non-recourse loan to purchase commercial property, like a warehouse.⁴
• Some business equipment purchases: In some cases, business owners may buy equipment with non-recourse financing. If the business defaults, the seller seizes only the equipment used as collateral, even if its value has gone down due to use.⁵

What happens if a borrower can’t repay a non-recourse loan?

If a borrower is facing financial difficulties and can’t repay their non-recourse loan, the lender can only take possession of the collateral named in the loan contract. If the value of the collateral doesn’t cover the full balance owed, the borrower is not responsible for the difference.

Defaulting on a non-recourse loan may still leave a serious negative mark on the borrower’s credit history.⁶ It’s important to stay up to date on payments and to communicate with your lender if you’re having trouble keeping up.

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Know your rights as a borrower

Learning about different types of loans can help you become a more informed borrower. But before you sign any loan agreement documents, it’s important to understand all the terms. Never hesitate to ask lenders questions and do your own research. When you understand your responsibilities and rights, you can borrow with confidence.

Sources

1, 5 https://www.irs.gov/publications/p925
2, 3, 6, https://www.investopedia.com/ask/answers/08/nonrecourse-loan-vs-recourse-loan.asp
4 https://www.investopedia.com/terms/n/non-recoursefinance.asp
8 https://www.experian.com/blogs/ask-experian/how-does-default-impact-credit/