What’s the Difference – Recourse vs. Non-Recourse Loans

Key Takeaways

• Loans are classified as either recourse or non-recourse.
• Non-recourse loans restrict the right of a lender to go after the income and assets of a borrower for repayment of a loan.
• Recourse loans allow lenders to obtain repayment from the personal assets and income of a borrower.
• Lawsuit loans provide a cash advance based on a lawsuit’s anticipated settlement or verdict.

What is the typical loan process?

The typical loan process starts with an application completed by the borrower. The application includes details about the borrower’s employment, income, bank accounts, and other assets they own.

Lenders review the application and order a credit report. Banks, credit unions, and other lenders use the credit report and a borrower’s credit score to decide whether to approve the borrower for a loan.

A history of borrower defaults and a low credit score usually results in a lender refusing to extend credit. A borrower with a poor credit history may be offered a loan, but it usually has a higher interest rate because there is a greater risk of borrower default.

If a borrower is approved for a loan, the lender prepares a loan agreement that includes the terms of the loan, including:

• Loan amount.
• Interest rate charged by the lender.
• Term or length of the loan, which is how long the borrower has to repay the debt.
• Amount of the monthly payment expected from the borrower.
• Loan collateral, if any.

Some types of loans may require collateral from a borrower. Collateral is one or more of a borrower’s assets the lender has a right to seize in case of a borrower default. For example, a car loan usually requires collateral in the form of a lien filed by the lender, giving it the right to take the car if the borrower defaults by making the monthly payments on the loan.

Mortgage loans are another type of loan that includes collateral. The collateral for a mortgage loan is usually the residential or commercial real estate purchased using the loan proceeds. Sometimes, if the value of the collateral is less than the loan amount, a lender may require additional collateral.

Depending on the terms of a loan agreement, a lender may have the right to take the collateral when a borrower defaults and still bring legal action to go after additional assets owned by a borrower. For example, a lender that gives an auto loan with the car as collateral may take the vehicle when the borrower defaults.

If the value of the collateral is not enough to repay the remaining loan balance, the lender may bring legal action to go after the income and additional assets of the borrower to recover the balance of what is owed. The ability of financial institutions to foreclose on real property, garnish wages, or go after additional assets of a borrower beyond the collateral depends on whether it is a recourse or non-recourse loan.

What is a Recourse Loan?

Recourse loans are a type of debt that permit a lender to bring legal action against a borrower who defaults in repaying a debt. If the debt is a real estate loan, an auto loan, or a personal loan that includes a requirement for collateral, the lender would first seize the asset pledged as collateral.

The lender arranges for the sale of the collateral with the proceeds from the sale, usually a public auction, applied toward repayment of the debt owed to the creditor. It frequently occurs that the value of the collateral is not enough to satisfy the debt owed, so the creditor under a recourse type of loan has additional options available to it.

A recourse loan agreement gives the lender the right to bring legal action when a borrower defaults in repaying the debt. This is in addition to foreclosure of the mortgage the creditor holds on the borrower’s real property or seizing a car pledged as collateral to secure repayment of the debt.

If a lender wins in its legal action, a court awards it a judgment against the borrower. The judgment gives the lender or creditor the right to use any legal method granted by state law to recover what it is owed. Judgment creditors have the right to garnish a debtor’s wages. Garnishment orders an employer to withhold a percentage of the weekly earnings of a debtor, and turn it over to a creditor as payment toward a judgment.

A judgment also lets a creditor use legal procedures under state law to seize the bank accounts and personal assets of a borrower who defaulted in repayment of a loan. The reason creditors may seize assets and garnish wages is because recourse loans impose personal liability on a borrower who defaults and fails to comply with the loan terms.

You may be wondering why a borrower would sign a loan agreement for a recourse loan. One reason is that recourse loans generally have lower interest rates than non-recourse loans because of the extent of the remedies lenders of recourse loans have in case of default by a borrower. 

Another reason that banks and other financial institutions rely on recourse loans for their auto loans, home loans, and personal loans is to reduce their risk of being unable to recover the money they lend in case of a borrower default.

What is a Non-Recourse Loan?

Other than successful business enterprises, such as commercial real estate investment firms, with excellent credit histories, the average borrower may find it difficult to convince a lender to approve them for a non-recourse loan. 

Non-recourse debt usually has a higher interest rate and the value of the collateral must exceed the amount borrowed to protect the lender in case of default.

Non-recourse loan agreements do not impose personal liability on a borrower. In case of default, a lender may sell the collateral. It cannot bring legal action against a borrower, get a judgment, garnish wages, or seize other assets in case of default.

If you find a lender offering non-recourse loans, be prepared to pay a higher interest rate. You may also have to come up with a larger down payment for the real estate or car you want to purchase to keep the amount borrowed lower than the market value of the collateral.

Main Differences Between Recourse and Non-Recourse Loans

The following are some of the differences between recourse and non-recourse loans:

• Recourse loans authorize a lender to take legal action against a borrower who defaults in repayment of the debt and sell assets or garnish wages of the borrower. 
• A non-recourse debt limits legal action by a lender to selling collateral in case of default by a borrower. 
• Recourse loans allow lenders to seize other assets in addition to collateral and garnish wages if the market value of the collateral is not enough to repay the debt. 
• Lenders have a greater risk of loss with non-recourse loans, so they charge higher interest rates than they do for recourse loans.
• More financial institutions offer recourse loans than they do non-recourse loans to minimize their risk of loss if a borrower defaults.

Are Lawsuit Loans Recourse or Non-Recourse Loans?

A lawsuit loan is a form of non-recourse loan. A lender agrees to give a borrower a cash advance for a percentage of the settlement value of a pending lawsuit. For example, if a borrower has a personal injury legal action pending, a lawsuit lending company will give a cash advance based on its expected settlement value. 

The loan agreement makes the settlement or verdict in the lawsuit the only source for repayment to the lender of the cash advance plus interest. The borrower has no personal liability if the case is lost, which makes it a non-recourse loan.

The application process for a lawsuit loan is different from what you will find when applying to a lender for a recourse loan. Because it’s a non-recourse loan, you will not be asked about employment, income, or the value of assets that you own. 

The lawsuit funding company does not do a credit report or check your credit scores because it’s only interested in the value of your lawsuit and not in your personal ability to repay the loan if you lose the case.