Usually, debt or loan is secured against collateral, say ‘home’ in a home loan. In case the borrower defaults, the lender has the right to recover the money from the collateral asset. But the lender might or might not be able to recover the full amount of his money with the collateral. And, in such a case, he may also make a charge against the personal asset of the borrower to recover his money. Such a loan is called a recourse loan/debt.
A loan can be of two types – recourse and non-recourse. The difference between recourse and non-recourse loan/debt is that of personal liability. Under a recourse loan/debt, the borrower can be personally held liable in case of default. Whereas, under a non-recourse loan/debt, the borrower is liable to the extent of the collateral only. Thus, if a borrower defaults on a non-recourse loan, the lender can only come and seek the collateral that was held against the loan. In this article, we will see the differences between recourse and non-recourse loan/debt.
Example of Recourse vs Non-Recourse Loan
Assume Mr. John and Mr. Donald have purchased a home with a recourse loan and non-recourse loan respectively. Under the situation of default:
- Mr. John, who took a recourse loan: Apart from his home (i.e., the collateral in this case), he is also liable to pay the loan with his personal assets.
- Mr. Donald, who took a non-recourse loan: The lender will take over the home (i.e., the collateral in this case), but he is not liable to pay the loan with his personal assets.
In other words, in a recourse loan, the claim amount is over and above the collateral value. One can realize it from the borrower’s personal assets. Whereas in a non-recourse loan, the borrower is not liable to pay anything over the given collateral.
Difference between Recourse and Non-Recourse Loan/Debt
The following are the differences between a recourse and a non-recourse loan.
Action in Case of Default
As we have already read that the first and foremost difference between a recourse and a non-recourse loan is the charge on personal assets. The lender has the power to seize the collateral. But, if the loan is not settled by selling off the collateral security, the lender can also claim the money from the borrower’s personal assets in case of recourse debt. While, in the case of non-recourse debt, the lender’s powers are limited to pursuing debt through the collateral secured against the borrowed amount. The lender cannot proceed toward the personal assets of the borrower.
Level of Risk
From the point of a borrower, recourse debt is riskier as in this case, his personal assets can also get seized. But, from the point of the lender, a non-recourse loan is riskier as in this, he doesn’t has full security towards the money lent by him.
Interest costs are higher in a non-recourse loan as compared to a recourse loan because the lender cannot claim anything more than the collateral. So, to compensate for the risk, he keeps the interest rate high while providing a non-recourse loan.
Who can Avail of these Loans?
Borrowers having high credibility, good repute, and do not make default can avail of a non-recourse loan. While borrowers whose chances of default are higher get a recourse loan.
A lender might be more comfortable lending a higher amount of money under a recourse debt agreement, subject to the background check and credibility of the borrower. The principal borrowing amount in question is usually lower under non-recourse debt than under recourse debt.
Impact of Market Conditions
When the credit market conditions are tough and credit is not available easily, the lender generally has greater power and is able to impose tougher credit terms. One can secure lending under a recourse loan agreement in such a case. But, under a strong macroeconomic backdrop, when the credit market conditions favor a buyer, the borrower, and the lender generally end up settling for a non-recourse loan agreement.
In recourse debt, tax implications are twofold. If the lender forgoes any outstanding portion of debt not paid by the borrower, the forgone portion becomes taxable for the borrower as income. The tax implication happens in the year in which the asset is foreclosed/sold. The gain is reported as income, and loss cannot be deducted from income, so are non-deductible losses.
The ordinary income of a borrower remains unaffected in a non-recourse debt since the liability is restricted to the collateral. Thus, non-recourse debt tax implications are minimal for the borrower. Suppose the borrower surrenders the collateral in return for the cancellation of non-recourse debt. In that case, any amount over the canceled debt and collateral’s adjusted basis is recognized as a gain from the disposal of such collateral or property.
Table of Difference
Let us summarize the difference between a recourse and a non-recourse loan.
|Basis||Recourse Loan||Non-Recourse Loan|
|Charge on Personal Asset||Personal assets can be seized to recover the amount in case of default||No charge can be made on the personal assets of the borrower|
|Degree of Risk||For lenders: lower risk|
For borrowers: higher risk
|For lenders: higher risk|
For borrowers: lower risk
|Interest||Low-interest cost||High-interest cost|
|Principal Amount||Due to lesser risk to the lender, he may offer more principal amount||The principal amount is lower due to the higher risk to lenders|
|Market Conditions||In tough credit market conditions, lenders can easily impose recourse loan||When credit market conditions favor a buyer, he can easily get a non-recourse loan|
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