When you’re buying a car, a home or any other big-ticket item, you can count on being faced with a pile of binding legal documents waiting for your signature if you’re financing the purchase. The problem, of course, is that these documents are filled with legal terms and mumbo jumbo that can leave you scratching your head. What exactly are you getting into? Are you signing away your firstborn child? Not if you’re taking out a non-recourse loan.
How Do Non-Recourse Loans Work?
The term non-recourse means that you’re not personally responsible for the debt. Yes, that’s tricky. You're the one who’s taking out the loan, so don’t you have to repay it? Contractually, yes, you do. The “personally” part doesn’t come into play unless and until you default on the loan. It means that you remain personally liable for any balance due on the loan even if your home, your vehicle or other collateral has been seized for nonpayment.
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What Is the Difference Between Recourse and Non-Recourse Debt?
In simplest terms, a non-recourse loan benefits you. A recourse loan benefits the lender. When you default on a loan, the lender’s first – and sometimes only – remedy is to take possession of the property you financed and pledged as collateral. The lender will foreclose on your home or repossess your auto. If you have a non-recourse loan, that’s the end of it. That’s all the lender can do to try to recoup the money it loaned you. It will sell the property to try to get at least some repayment of the delinquent debt, but if it isn’t able to sell it for as much as you owe, the lender is out of luck. This difference between the sales price and the amount you owe is referred to as the deficiency balance.
A recourse loan is just what it sounds like. The lender literally has additional recourse after selling your property. It can pursue you directly and personally for any deficiency balance. This means it can get a court order to seize your other assets and sell them, too, or even garnish your pay. In either case, the default and repossession or foreclosure will still show up on your credit report.
What Is Qualified Non-Recourse Financing?
A non-recourse loan might sound like a pretty good deal, but there’s typically a price to pay for such an arrangement. Borrowers with poor, or even barely acceptable, credit typically do not qualify for non-recourse financing. The whole idea behind a recourse loan is to try to ensure that the lender will get as much of its money back as possible in the event the borrower can’t or doesn’t repay the debt. Someone with poor credit is more likely to default than a borrower with impeccable credit. Non-recourse loans are generally only offered to those with perfect credit.
Non-recourse loans are typically smaller as well, such as if you made a significant down payment so you’re financing less. And you can expect that the interest rate will be higher because the lender is going out on a limb by extending such a loan.
How Do You Know What Kind of Loan You Have?
Your type of loan will be indicated in the contract documents or mortgage agreement you sign, but it can be camouflaged by more legalese. Ask and clarify before you sign – or better yet, have an attorney review the documents. In all likelihood, you discussed all this with your lender when you were negotiating for the loan, because having a non-recourse clause in place affects other terms.
A non-recourse loan spares the borrower further collection efforts after foreclosure or repossession.
Beverly Bird is a practicing paralegal who has been writing professionally on legal subjects for over 30 years. She specializes in family law and estate law and has mediated family custody issues.