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Recourse loan vs. non-recourse loan

Before signing any loan agreement, it’s important to examine all of the details carefully. This includes the consequences of non-payment. The borrower is personally responsible for recourse debt, while banks take on more of the risk with non-recourse debt.

What is recourse debt and loan collateral?

Secured debt like auto loans, and credit cards are examples of recourse debt. This means that when borrowers default, lenders can recover the balance with collateral. When the collateral isn’t sufficient to cover the full outstanding loan balance, lenders can take it a step further to seize borrower assets.

With aggressive methods to recover the loan, recourse debt is usually preferred by lenders as it presents a much lower level of risk. In return, lenders can provide lower interest rates and wider availability for this type of loan.

Non-recourse debt is also secured with loan collateral, but if the borrower defaults, the lender can’t go after any additional assets. Some states treat home mortgages as non-recourse debt, while others will classify it as recourse debt. Because there’s higher risk involved for the lender, interest rates are higher with non-recourse debt.

What is a recourse loan?

If you sign paperwork for any recourse loan, you’re assuming 100% personal responsibility for paying it back. Typical examples of recourse loans include:

  • Credit cards

  • Auto loans

  • Cash loans

  • Home loans (in most states)

If you break the loan agreement, the lender can repossess or seize the loan collateral. The problem is, sometimes the collateral isn’t enough to repay the entire outstanding amount. This is particularly true for items like cars, which depreciate over time. In that case, the lender must turn to the courts for a deficiency judgment. This allows the lender to chase after additional assets.

These legal actions could include:

  • Levies on assets: Creditors can take additional assets that weren’t offered as original loan collateral. They might be able to levy funds directly from your bank account or gain a portion of your home’s value after it’s sold.

  • Wage garnishment: The lender might gain the legal right to take a percentage of your pay until the full loan amount is paid off.

  • Collections agency: The lender might sell your debt to a professional collection agency, which will pursue additional measures.

What is a non-recourse loan?

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. Unlike a recourse loan, they can’t go after your assets or garnish wages.

Examples of non-recourse loans include home loans, in 12 non-recourse states. In the case of a non-recourse home loan, the lender can foreclose on the property but is unable to go after any other assets.

Recourse vs. non-recourse: which is the best option?

There are pros and cons to both types of loan, but ultimately the choice of recourse vs. non-recourse boils down to what lenders are willing to offer.

Benefits of recourse loans for borrowers include lower interest rates and wider availability. You might be able to secure a recourse loan with a less-than-perfect credit score because the lender has multiple avenues to pursue the debt if necessary.

The benefits of non-recourse loans include the security of not having your assets taken. However, lenders are more risk-averse with this type of loan, and many banks won’t offer them at all. When they do, expect to pay higher interest rates, while you’ll also need a high credit score to qualify.

Ideally, you should only borrow what you know you will be able to repay. Ultimately the best loan type for you will depend on your current needs, credit rating, and your ability to make on-time payments to avoid default.

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