Non-Recourse Loan

A non-recourse loan refers to the type of financing for borrowers where they have to back the borrowed amount against security, also termed collateral. This, in turn, assures lenders that in the event of default, they will have the borrowers' property to get back the amount.

The collateral, in this case, is normally the property or project that borrowers invest in. The non-recourse loan definition differs from the recourse loan as the latter holds borrowers personally liable for missed repayments, giving the lenders the liberty to use any of their assets to get back the lent amount in case of default.

• A non-recourse loan is backed by collateral, which the lenders use to cover up the loan amount in the event of defaults. The rest fall under recourse loans.
• It is a great source of funds to invest in properties like apartments, complexes, strip malls, etc.
• For high lending capital, the lender keeps a guarantee in collateral securities. Collaterals are generally real properties.
• Due to the higher risk of repayment, lenders charge a higher interest rate.

A non-recourse loan is a category wherein the borrower has to attach some collateral security to the loan contract, like property, equipment, bank fixed deposits, etc., to secure the loan for the lender. Collateral security is generally the property in which the borrowed amount is invested. In default, the lender can seize the collateral to clear the dues.

The borrower under a non-recourse debt is not personally liable. That means if the borrower defaults, the lender can finally recover the dues by seizing the collateral. But if the collateral does not cover the full value of the loan, the lenders cannot ask the borrowers to pay further.

The need to distinguish a recourse loan from a non-recourse loan arises if the borrower defaults and some money remains unrecovered despite the foreclosure of the property. In short, the involvement of collateral security differentiates recourse from non-recourse loans.

One’s eligibility for a non-recourse loan depends on the criteria fulfilled. The borrowers are eligible only if:

• They satisfy the approval requirements. Normally, borrowers with high credit scores and a low debt-to-income ratio are hardly allowed such loans.
• The borrowers are ready to pay higher interest rates.
• They take mortgage finance, which is quite common if they reside in one of the 12 non-recourse states, which include Arizona, Oregon, Texas, Connecticut, California, Alaska, North Carolina, North Dakota, Utah, Minnesota, Idaho, and Washington.

Let us consider the following instances to understand how the non-recourse loan agreement or arrangement works:

Example 1

Ms. Jolly and Mr. Happy both want to purchase houses individually. They take up loans of $240,000 to be paid within two years, with $10,000 being the monthly installment.

Mr. Happy purchases the house on a recourse loan, i.e., without providing any collateral to the lender and becoming personally liable in case of defaults. On the other hand, Ms. Jolly mortgages the house purchased against the loan taken, making the asset the collateral.

Assume both get defaulted after paying 4-month installments of $40000, i.e., a total of $200,000 remains unpaid. The current market value of the houses is $180,000 only. The lender seizes the houses of both borrowers and recovers $180,000. Still, an amount of $20,000 remains unrecovered.

Now Mr. Happy, who took a recourse loan, has to pay $20,000 through his other assets further, but Ms. Jolly is not personally liable to pay any additional amount. Thus, in the case of a non-recourse loan for real estate, the borrowers remain safe even in the event of default.

Example 2

In October 2023, Park Hotels & Resorts Inc. announced one of its trustees for $725 million non-recourse CMBS loan filing a legal suit against two of its unit in San Francisco. In the appeal, the trustee requested the court to appoint a receiver to recover the loan by selling the properties in question and ensure cessation the loan payment.

The receiver, as appointed, would look after the possessions of the hotels and retain the labor force to run the hotel smoothly. However, the same person would be responsible to sell the unit in case it fails to repay even after the extended period.

The tax implications differ based on the type of loan one takes up. The U.S. Internal Revenue Service (IRS) has different taxation guidelines for recourse and non-recourse finances. The authorities consider any loan amount canceled or forgiven as taxable. However, if that canceled or forgiven amount falls under the non-recourse loan category, taxpayers do not possess any tax liabilities.

If a foreclosure occurs. Lenders sell a house at a cost more than the amount borrowers owe; the latter has to pay taxes on the profits made.

In a recourse loan, the borrower guarantees repayment of the loan as and when due. On the other hand, in a non-recourse loan, the borrower does not personally sign the contract to become a guarantor. Hence no personal liability or risk exists for the borrower.

Let us have a quick look at the differences between the two loans:

This has been a guide to What is Non-Recourse Loan & its definition. We explain how it works with an example, its taxation, & comparison with a recourse loan. You can learn more about Corporate Finance from the following articles –

• Recourse in Factoring Meaning
• Loan vs Lease
• Liability vs Debt
• Defalcation