Non-Recourse Loans: What Are They?
You’ll probably end up needing a loan at some point in your life.
Whether you need it for your business or something like a new car, you’ll need to borrow money at some point. But before you do, you have to understand what kind of loans you’ll be working with.
Take a look at this complete guide to recourse and non-recourse loans.
What Are Non-Recourse Loans?
The best way to understand a non-recourse loan is to think about secured and unsecured debt. Though most people already understand these two types of debt, we’re going to break the two down so they are completely clear.
This is a debt that requires collateral, like a mortgage. In this case, a borrower’s house is the collateral. If the borrower fails to pay off the debt, the lender can start the process of foreclosing the house.
In other words, the lender is claiming the house to make up for the remaining value of the debt.
Unsecured debt doesn’t require a collateral, but it does have much higher interest rates. Think about things like credit card debt. This kind of debt is more risky for the lender, and the increased interest rates help balance that risk out.
The two Different Kinds of Recourse Loans
Like secured and unsecured debt, there are two different types of recourse loans. And, also similarly, the difference between the two loans comes down to collateral and default.
A recourse loan has collateral, and in the case of the default, the lender is able to seize that collateral. However, they are also able to hold the borrower personally liable for the deficiency balance as well.
This type of loan also has collateral, and the lender can take the collateral if the borrower defaults on the loan. The difference is the lender is unable to pursue the borrower for the extra deficiency balance.
What Is a Deficiency Balance?
Sometimes, the collateral doesn’t cover the entire value of the loan. In this case, the amount that the collateral doesn’t cover is called the deficiency balance. This means if the collateral isn’t enough, a recourse loan lender can take additional compensation for the loan.
Give Me an Example
Let’s say you want to buy a new house, so you take out a loan of the full value of the house. You use that money to buy the house, and you then start paying off the loan.
Unfortunately, something happens a few year later, and you default from the loan.
Let’s also assume you didn’t take very good care of the house or that the neighborhood has gotten worse. Either way, the house is now worth less than it was when you bought it.
If You Had a Recourse Loan…
The lender could take your house and demand other compensation for the lost value. If the value of your house lower by $8,000, the lender could take a deficiency balance of $8,000.
If You Had a Non-Recourse Loan…
The lender could take your house, but that’s all they could take. They wouldn’t be able to make up for the loss of value.
Are Non-Recourse Loans Right for You?
Before you make a final loan decision, spend some time figuring out what loan will work best for you. Make sure you talk to the lender and understand the loan completely, no matter which one you choose.
At that time in your life when you need a loan? Contact us and we’ll give you some options.