When it comes to borrowing money, there are a lot of terms that can be confusing for people who don’t have a lot of experience with the financial jargon used in the lending business. It can be confusing trying to understand the difference between secured or unsecured loans and fixed or variable rates. But an even more complex concept to understand is the difference between non-recourse and recourse loans.
However, understanding the distinctions between these two very different types of loans can be critical if you’re about to borrow money via a mortgage, auto loan, personal loan, or any other type of loan.
What is a Non-Recourse Loan?
The difference between recourse and non-recourse loans boils down to what assets your lender can potentially seize if you are unable to repay your loan. If you get a non-recourse auto loan, for example, your car would likely be used as collateral on your loan. That means that, if you fail to repay your loan, your lender can take possession of your car and sell it in order to pay off the loan.
If the value of your car has depreciated more then the amount you owe at the time they repossess your car, then the lender is out of luck. In a non-recourse loan, the lender cannot go after any of your other assets to make up the difference. In fact, if you get a non-recourse personal loan without collateral and you used it to buy that car, your lender can’t seize your car or any other assets.
What is a Recourse Loan?
A recourse loan is slightly different in that, in addition to potentially requiring collateral that can be seized the in event you default, the lender has the ability to go after your other assets or income in order to be repaid the full amount if seizing and selling your collateral is insufficient to repay your loan.
For example, if you have a mortgage and the value of the real estate in your area has depreciated since you bought your house, selling your house in the event you default on your mortgage might not be enough to repay the amount you owe on your mortgage. In that case, a lender in a recourse mortgage could also potentially seize your car, or that vacation home that you own, or have your wages garnished in order to pay off the rest of your mortgage.
What Are the Differences Between Recourse and Non-Recourse Loans?
Obviously, the biggest difference between a recourse loan and a non-recourse loan is that with a recourse loan you are personally liable to repay the lender in full when you default on your loan.
Another difference between these loans are in the type of borrowers that are more likely to be offered non-recourse or recourse loans. People with better credit will be more likely to qualify for a non-recourse loan than those who have fair or poor credit. If you have less than ideal credit, the only way that you might be able to get approved for financing is with a recourse loan or you might have to pay a significant premium in interest in order to get a non-recourse loan. That’s because the lender takes on more risk with non-recourse loans than with recourse loans.
How Are Recourse and Non-Recourse Loans Similar?
Other than the fact that with a non-recourse loan your assets are better protected, there isn’t much difference between recourse and non-recourse loans. Both recourse and non-recourse loans often still require collateral when you’re borrowing to buy a car or a house. Similarly, in both cases if you default on the loan your credit score will be affected.
It’s also important to note that even if you get a non-recourse loan, that doesn’t mean that you are not personally liable for repaying the outstanding balance on your loan in all circumstances. Even non-recourse loans often have what’s known as carveout provisions. If you’ve done things like committed fraud or misrepresentation, failed to keep your property insured or pay property taxes, or filed for bankruptcy there is a chance that a lender could potentially come after your assets even if you have an non-recourse loan.
Author: Jeff Gitlen
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