Recourse Loan (Debt)
When a borrower fails to make loan payments under a recourse obligation, they are held personally accountable. If there is a balance outstanding towards the debt after the sale of collateral, the lender may pursue additional collateral not listed in the loan contract, such as the borrower's personal assets. When compared to non-recourse loans, recourse loans are in the lender's favor.
To cover the gap between the asset's market value and the loan sum, the lender may pursue additional assets owned by the borrower. This is true even if the other assets weren't used as loan collateral.
Consider a scenario in which the proprietor of a small tech repair business desires to grow and quit operating from his house. He takes out a $750,000 recourse loan to buy a house that he can live in and work out of. His company fails during the first year as a result of mounting debt.
He tries to sell the property, but due to a downturn in the market, the building is now only worth approximately $600,000. In order to recover the additional $150,000 he owes, the lender may subsequently pursue his other assets, such as his home and his bank account(s).
Lenders with recourse rights may pursue the personal and sporadically business bank accounts of borrowers. They frequently have the right to pursue part of a person's sources of income, such as garnishing their wages until the debt is paid. The lender may profit financially by using the borrower's commissions, bonuses, and perhaps even their pension or retirement account.
Non-recourse loans solely use the collateralized asset. As an illustration, mortgages are often non-recourse loans. They merely put their house up as collateral. In the event that the borrower defaults on the loan, the lender will only be able to confiscate the property. In order to recoup the loan amount, the lender cannot seize the borrower's personal bank accounts or any other property.
Contrarily, hard money loans are categorized as recourse loans even when they are used to buy real estate.
In some cases, lenders offer recourse loans despite knowing in advance that the applicant will probably be unable to pay back the loan. The lender wants the borrower to make a default so they can seize the property. The lender takes this action because they think they can buy the property and sell it for more money than the initial loan was worth.
In a partnership with recourse debt, one or more partners may be held personally responsible for a loan default. Depending on the nature of your business partnership, the effects of a recourse loan arrangement may be as follows:
- General Partnerships: All partners in general partnerships are responsible for the company's recourse debts. This means that the lender may pursue the partners' personal assets if the partnership defaults on the loan and the proposed security is insufficient to pay off the balance.
- Limited Liability Company: Partners in a limited liability firm have limited personal liability, as the name implies. As a result, even in the majority of recourse loan cases, the LLC's participants could not be held personally accountable for the obligations of the business.
- Recourse loans make the borrower fully responsible for the loan balance; in the event of a default, the lender may use additional legal actions to recoup the debt.
- Hard money loans used to buy real estate are frequently recourse loans, unlike the majority of mortgages.
- Lenders may pursue the borrower's personal bank accounts or even monthly income in an effort to recoup the loss from a defaulted loan.