Recourse Loan
What is a recourse loan?
When a borrower defaults on a recourse loan, they are personally responsible for the remaining debt. If the sale of collateral doesn't cover the full amount owed, the lender can go after the borrower's other assets, such as personal savings or property. This makes recourse loans more favourable for lenders compared to non-recourse loans.
How do recourse loans work?
Even if the collateralised asset's value doesn't cover the loan, lenders can pursue additional assets to make up the difference. This means that the lender isn't limited to just the collateral listed in the loan agreement.
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Example of a recourse loan
Imagine Sarah, who owns a small bakery. She wants to expand her business by opening a new store, so she takes out a $500,000 recourse loan to buy a commercial property. However, after a year, her business struggled due to unexpected competition and rising costs.
Sarah decides to sell the property to pay off the loan, but a downturn in the real estate market means the property is now worth only $400,000. To recover the remaining $100,000, the lender can go after Sarah's other assets, including her personal savings and her car.
How do lenders recover their money?
Lenders with recourse rights can pursue the borrower's personal and sometimes business bank accounts. They might even garnish wages until the debt is repaid. Lenders can also target the borrower's commissions, bonuses, and possibly even their pension or retirement accounts.
Recourse loans vs. non-recourse loans
- Non-Recourse Loans: These loans are secured only by the collateralised asset. For example, most mortgages are non-recourse loans. If the drawee defaults, the lender can only seize the house, not the borrower's other assets.
- Recourse Loans: In contrast, recourse loans allow lenders to go after additional assets beyond the collateral. Hard money loans, often used for real estate, are typically recourse loans.
In some cases, lenders might offer recourse loans, knowing that the borrower may default. This permits the loan provider to seize the property and potentially sell it for more than the loan's value.
Recourse debt in a partnership
In partnerships, recourse debt can mean personal liability for the partners:
- General Partnerships: All partners are responsible for the business's recourse debts. Lenders can go after the partners' personal assets if the partnership defaults.
- Limited Liability Company (LLC): Partners typically have limited personal liability. Even with recourse loans, LLC members may not be personally responsible for the business's debts.
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Conclusion
- Recourse Loans: Borrowers are fully responsible for the loan balance. Lenders can take additional legal action to recover the debt if the borrower defaults.
- Hard Money Loans: Often, recourse loans are used to buy real estate, unlike most mortgages.
- Lender Actions: To recover losses from a defaulted loan, lenders can pursue personal bank accounts or even monthly income.
Fun fact: The term "recourse" comes from the Latin word "recursus," meaning "a return or retreat." This reflects the lender's ability to reclaim funds by pursuing the borrower's assets!
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