Recourse vs Non-Recourse Debt
When a bank or financial institution grants loans they require an asset to be pledged as collateral for the loan, which usually is the asset or property that the loan funds were utilized to purchase. The collateral that is pledged to the bank is used by the bank to recover any losses in the event that the borrower defaults on his loan payments and is unable to meet his obligations. In this way, collateral acts as an insurance policy for lenders. A bank may grant different types of loans for different purposes. These loans can be divided into two types; recourse and non-recourse. The article offers a clear explanation of the two different types of debts and explains the similarities and differences between recourse and non-recourse debt.
What is a Recourse Debt?
A recourse debt is a loan for which an asset or property is pledged as collateral. In the event that the borrower defaults on his loan the lender has the authority to seize the collateral and recover his debt from the sales proceeds of the asset. However, if proceeds from the asset are insufficient to recover the loan amount, the lender can then seize the borrower’s other assets such as bank account balances, salaries, houses, vehicles, etc. A recourse debt is beneficial to the lender as it allows them the authority to recover the full amount due by going after other assets that the borrower owns.
What is a Non-Recourse Debt?
A non-recourse debt is the exact opposite of a recourse debt. If the borrower fails to pay his loan the lender can utilize the asset pledged as collateral to recover any outstanding debts, however, the lender does not have the authority to go after other assets held by the borrower. If the asset pledged does not cover the full amount of the loan the lender has no option other than to bear the loss. A non-recourse loan is preferred by a borrower as it offers a sense of security that the lender cannot seize any other property that the borrower owns and his debt obligations ends with the asset that was pledged as collateral. On the other hand, non-recourse debts are not favourable for a lender who may have to absorb part of the loss.
What is the difference between Recourse Debt and Non-Recourse Debt?
The difference between the types of debts lies in the assets that a lender can pursue to recover losses in the event that a borrower fails to meet his loan obligations. In both recourse and non-recourse debts, the lender can recover losses by selling off the asset that was pledged as collateral. However, in the event that the asset pledged does not cover the full loan amount, the options for the lender under a recourse debt are more favorable than for a non-recourse debt. In a recourse debt, the lender can go after any other assets that the borrower owns until the full amount is recovered. In a non-recourse debt, the lender can only recover the amount from the asset pledged as collateral and has to suffer the loss arising from the difference. Borrowers prefer to take out non-recourse loans. However, the interest rates on such loans are higher and are usually only available to individuals or businesses that have very high credit scores and the lowest probability of default. In addition, a non-recourse loan may preserve the borrowers other assets, but on default, harms the borrower’s credit score, as is the same for defaulting on recourse debts.
Summary:
Recourse Debt vs Non-Recourse Debt
• When a bank or financial institution grants loans they require an asset to be pledged as collateral for the loan. The collateral that is pledged to the bank is used by the bank to recover any losses in the event that the borrower defaults on his loan payments.
• In a recourse debt, the lender can recover the loan amount by selling off the collateral, and if this does not cover the full amount, the lender can go after any other assets that the borrower owns until the full amount is recovered.
• A non-recourse debt is the exact opposite of a recourse debt. If the borrower fails to pay his loan the lender can utilize the asset pledged as collateral to recover any outstanding debts. Nevertheless, the lender does not have the authority to go after other assets held by the borrower.
• Borrowers prefer to take out non-recourse loans. However, the interest rates on such loans are higher and are usually only available to individuals or businesses that have very high credit scores and the lowest probability of default.
• Lenders prefer recourse debts while borrowers prefer non-recourse debts.