Before You Sign: Important Facts About Recourse Loans You Can't Ignore

A recourse loan is a type of loan that allows the lender to go beyond the collateral provided if the borrower fails to repay the debt. In simple terms, it means if you default on your loan, the lender can take not just the property you put up as collateral (like a house or car) but can also go after other assets you own to recover their money.

This could include your savings, investments, or even a portion of your wages. Recourse loans are common in certain real estate transactions and are designed to give lenders more protection when lending large sums of money.

In this blog, we’ll break down about before you sign important facts about recourse loans you can't ignore.

We’ll also provide a realistic example and explore the latest trends in 2024.

What Is a Recourse Loan?

A recourse loan is a secured loan, meaning it is backed by some kind of asset, often property or real estate. However, what makes a recourse loan different is that if the borrower defaults—meaning they stop making payments—and the collateral isn’t enough to cover the remaining loan balance, the lender can go after the borrower’s other assets to make up the difference. This type of loan gives lenders greater assurance that they can recover their money.

For example..

Let’s say you take out a loan to buy a property and offer the property as collateral. If you fail to repay the loan, the lender can sell the property to recover their money. However, if the property is sold for less than what you owe, a recourse loan allows the lender to pursue your other assets, like your bank account or income, to make up the difference.

How Recourse Loans Work

When someone borrows money using a recourse loan, they are putting more than just the collateral at risk.

Here’s how it works:

1. Collateral: The borrower offers an asset, such as a house, as security for the loan. If they fail to make payments, the lender can seize this asset.

   
   

2. Asset Seizure: If the asset doesn’t fully cover the outstanding debt, the lender can pursue other assets. This might include savings, investments, or personal property.

   
   

3. Legal Action: The lender may also take legal action to collect the remaining balance by garnishing the borrower’s wages, which means taking a portion of their income until the debt is repaid.

   
   

Recourse Loan vs. Non-Recourse Loan

One of the key distinctions in real estate loans is the difference between recourse and non-recourse loans.

• Recourse Loan: As explained, the lender can seize the collateral and other personal assets if the borrower defaults.

• Non-Recourse Loan: In contrast, with a non-recourse loan, the lender can only seize the collateral and nothing more. If the collateral is sold for less than the outstanding loan balance, the lender has to absorb the loss. They can’t pursue the borrower’s other assets.

  
  

For instance, many traditional home mortgages are non-recourse loans, which means if a borrower defaults, the lender can take the house but not go after their other assets.

Realistic Example of a Recourse Loan

Let’s imagine you’re a property investor looking to finance a commercial real estate project. You take out a $1 million recourse loan to purchase an office building, using the building as collateral. If everything goes as planned, you make your monthly payments, and the loan is repaid in full.

However, let’s say the office building’s value drops because of a downturn in the real estate market, and you can no longer keep up with your payments. The lender forecloses on the building and sells it, but they only recover $800,000. Since this is a recourse loan, the lender can pursue your personal assets to recover the remaining $200,000. They might go after your savings, investment accounts, or even garnish your wages.

Why Do Lenders Offer Recourse Loans?

Lenders prefer recourse loans because they offer more security. In case of a default, the lender has a better chance of recovering the full loan amount, not just the value of the collateral. This is particularly important in situations where the value of the collateral could fluctuate, such as with real estate, where market prices can rise and fall.

Because of the extra security recourse loans offer, lenders may be more willing to offer lower interest rates or approve borrowers who might not qualify for other types of loans. For borrowers with limited credit histories or high-risk projects, a recourse loan might be the only option.

Advantages and Disadvantages of Recourse Loans

Advantages:

1. Easier to Qualify: Borrowers who might not qualify for non-recourse loans because of poor credit or risky projects may still be able to get a recourse loan.

   
   

2. Lower Interest Rates: Since the lender has more security, recourse loans often come with lower interest rates compared to non-recourse loans.

Disadvantages:

1. Higher Risk for Borrower: Recourse loans put more of the borrower’s assets at risk. If they default, they could lose not only the collateral but also other personal assets.

   
   

2. Potential Wage Garnishment: In some cases, the lender can garnish the borrower’s wages, meaning a portion of their income would be taken to pay off the debt.

Trends in 2024: The Return of Recourse Loans

In recent years, the real estate market has seen a resurgence of recourse loans, particularly in commercial real estate. The economic disruptions caused by the COVID-19 pandemic led to a rise in these types of loans as lenders sought more security in a volatile market. Developers and investors found that recourse loans offered access to cheaper capital, especially for projects in risky markets.

In 2024, interest rates have remained high, making borrowing more expensive. Recourse loans have become a viable option for borrowers who need to secure lower interest rates or who are unable to qualify for non-recourse loans.

For example..

Commercial real estate investors in sectors like multifamily housing or office buildings in urban areas are increasingly turning to recourse loans to finance their projects.

Recourse loans are a double-edged sword. They offer borrowers access to financing that might not be available through other types of loans and often come with lower interest rates. However, they also expose borrowers to greater financial risk because the lender can go after personal assets if the collateral doesn’t cover the debt.

Understanding the terms of a recourse loan is critical before entering into this type of agreement. For anyone looking to finance a real estate project, knowing the difference between recourse and non-recourse loans and the risks involved can make a significant difference in managing financial obligations.