There are many factors to consider when shopping for a mortgage: the amount you can afford, the interest rate, your comfort level with the lender and whether or not the lender services the loan. But there’s something else you should think about: Is your mortgage a recourse or nonrecourse loan? Below, learn about recourse loans and nonrecourse loans and which option is best for you.
Key Takeaways:
- Recourse loans and nonrecourse loans are both types of secured loans, but they differ in which assets a lender can pursue if the borrower defaults.
- Recourse loans favor lenders. If a borrower defaults on a recourse loan, the lender can seize the collateral and other assets to recoup any losses.
- Nonrecourse loans favor borrowers. Lenders can seize the borrower’s collateral in case of default, but their other assets are protected.
What Is A Nonrecourse Loan?
A nonrecourse loan is a type of collateral loan, or secured loan, where your property secures the debt and can be seized if you default on your payments. However, this loan type prohibits the lender from pursuing additional assets beyond the collateral, even if the value of that collateral isn’t enough to recoup their loss. For this reason, a nonrecourse mortgage loan favors the borrower. It assures they’ll never owe more on their loan than the asset is worth.
With a nonrecourse loan, if you fail to pay your mortgage and the lender forecloses on your home, that’s all they can legally do. If the lender sells the foreclosed property and doesn’t make their money back on the defaulted amount, it’s their loss. There isn’t any further legal action lenders can take to recoup lost funds from your personal assets.
What Is Nonrecourse Debt?
Nonrecourse debt is a type of debt that’s secured by collateral. This collateral is the only asset a lender can take if you default on the debt. The lender can use only that collateral to cover the amount of debt owed. If the collateral doesn’t cover the amount of debt, the lender cannot seize any other property or money from you.
Nonrecourse debt doesn’t get you off the hook for paying back what you owe. As a borrower, you’re responsible for paying back your loan. If you don’t, you’ll still lose that asset, the default will be on your record and your credit will take a hit.
What’s Your Goal?
Buy A Home
Discover mortgage options that fit your unique financial needs.
Refinance
Refinance your mortgage to have more money for what matters.
Tap Into Equity
Use your home’s equity and unlock cash to achieve your goals.
What Is A Recourse Loan?
A recourse loan is also a secured loan, but it allows the lender to pursue legal action even after they’ve seized your collateral. For this reason, recourse loans favor lenders, not borrowers. With a nonrecourse loan, the lender can lose money after selling your foreclosed house and will need to walk away without recouping the difference. With a recourse loan, a lender can potentially garnish your wages or pursue legal action to levy your bank account to make up for the amount they lost after calculating the amount recouped from selling your home.
Recourse Loan Example
A home loan and an auto loan are two common examples of recourse loans. Auto loans are typically recourse loans because car values are notorious for dropping as soon as you drive away from the dealership.
Let’s say you get a car loan for $20,000 to purchase a car. As you drive the car, the vehicle’s value drops over time. However, your loan amount remains the same. Let’s say that after a year of owning the car, you stopped making payments, but you still owe $16,400 on the loan. The lender could seize the car, but by now, the car is worth only $14,000. Because the loan is a recourse loan, the lender could still try to reclaim the additional $2,400 to cover the remaining debt.
Can Lenders Forgive Recourse Debt?
In some situations, rather than pursuing legal action, a lender may forgive a portion of the debt that isn’t covered by the collateral. For example, a lender may agree to a short sale or deed in lieu of foreclosure. This can not only help lenders avoid the long and expensive process of foreclosure, but it also helps borrowers settle their debts without worrying about further legal action.
In a short sale, you put your home up for sale and the lender chooses which offer to accept, agrees to take that sale price as the loan payoff amount and absorbs the rest of what’s owed. With a deed in lieu of foreclosure, you sign your home over to the lender instead of the lender foreclosing on the home. With this voluntary act, the lender agrees to forgive any remaining balance after the home is sold.
Though neither of these situations is ideal, they benefit both parties by resolving the debt and avoiding further legal disputes.
Ready To Become A Homeowner?
Get matched with a lender that can help you find the right mortgage.
How Do I Find Out Whether I Have A Recourse Vs. Nonrecourse Loan?
There are a variety of situations that can determine your loan’s terms. To know where you stand, look over your mortgage note. All the terms of your mortgage are included in that document. If you ’re facing foreclosure, contact an attorney or legal service for help.
Look Up Your State Law
Whether a loan is a nonrecourse loan generally depends on the laws of the state where the loan originates. There are 12 states that, by law, allow only nonrecourse loans. These “nonrecourse states” are Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah and Washington.
You can research whether you live in a recourse or nonrecourse state and learn how that can change with impending foreclosure. You may also be able to review your mortgage agreement, ask your lender or consult a real estate attorney.
Check What Type Of Loan You Have
Some types of home loans are nonrecourse by definition. For example, most reverse mortgages are nonrecourse loans, because financial products targeted at seniors are often afforded greater consumer protection.
Negotiate With Your Lender
A borrower with near-perfect credit might be able to negotiate with their lender to include a nonrecourse clause at no additional cost while shopping for a mortgage. But borrowers with lower credit scores would have to be willing to pay a higher interest rate for a nonrecourse loan.
Take The First Step To Buying A Home
Find a lender that will work with your unique financial situation.
Pros and Cons of Recourse Vs. Nonrecourse Loans
For borrowers, there are advantages to both recourse and nonrecourse loans, but there are downsides, too. Consider the pros and cons of each when taking out any type of secured loan.
Recourse Loan Pros And Cons
Recourse loans are generally riskier for borrowers because lenders can pursue assets beyond collateral in case of loan default. On the other hand, recourse loans tend to have lower interest rates than nonrecourse loans, and they may be easier to qualify for.
Recourse Loan Pros And Cons
| Pros | Cons |
|---|---|
| Potentially lower interest rates | Default can lead to losses beyond collateral |
| May be easier to qualify for | Borrower takes on more risk |
| Lenders may forgive recourse debt |
Nonrecourse Loan Pros And Cons
Nonrecourse loans favor borrowers. They involve less risk for borrowers because lenders can pursue only the loan collateral in case of default – nothing more. However, you can’t always get a nonrecourse loan, and you may need excellent credit to negotiate one. Plus, due to the added risk for lenders, nonrecourse loans typically come with higher interest rates.
Nonrecourse Loan Pros And Cons
| Pros | Cons |
|---|---|
| Less risk for borrower | Not always available |
| Loss is limited to collateral | May need near-perfect credit to negotiate a nonrecourse loan |
| Typically have higher interest rates |
Recourse Vs. Nonrecourse Loans: Key Differences
The main difference between recourse and nonrecourse loans is which assets of yours a lender can pursue if you (the borrower) can’t repay the loan.
But there are other key factors that distinguish recourse loans from nonrecourse loans:
- Who bears more risk: Nonrecourse loans are riskier for the lender. Recourse loans are riskier for the borrower.
- Interest rates: Since recourse loans are less risky for lenders, they’re usually offered at lower interest rates. Nonrecourse loans typically have higher interest rates.
- Eligibility requirements: Nonrecourse loans are typically offered more to borrowers who have great credit and are in good financial standing.
- Tax implications: There are no tax implications if you have a nonrecourse loan. But with recourse loans, if your debt is canceled by the lender following a foreclosure (meaning you don’t have to pay off a certain portion of the debt), you may be required to claim the portion of the debt that has been forgiven as income on your tax return.
Learn more: Use a mortgage calculator to find out how much your interest rate will affect your monthly payment and total cost of ownership.
Which Loan Option Is Best For You?
The best reason for choosing a nonrecourse loan is that it helps protect your other assets should you default on your loan. While you should never get a loan if you think you’ll default, a nonrecourse loan is less risky and provides an extra level of security should you ever fall on hard times. That said, you’re likely to pay a bit more in interest in exchange for protecting your assets.
Depending on where you live, you might not have a choice between a recourse and nonrecourse loan. Unless your property is located in a nonrecourse state, a recourse loan may be your only option.
If you do have a choice, a recourse loan could offer a lower interest rate. But you should consider this loan type only if you have a stable income and a very low risk of default.
The Bottom Line
Whether your mortgage is a recourse or nonrecourse loan may affect your interest rate and could impact how your lender proceeds in the event of a foreclosure. With a nonrecourse loan, you’ll never owe more than what your collateral is worth, but that extra protection comes with higher interest.
Though nonrecourse loans have benefits, they’re not always available. If you have questions about your loan type, you can always check your mortgage note or talk to your lender for more information.
Emily Batdorf
Emily Batdorf is a personal finance writer with five years of experience working with clients like Forbes Advisor, Yahoo! Finance, Credible, Experian and more. With a background in education, Emily loves making complex financial topics accessible to the public. She's written and edited hundreds of articles about budgeting, debt, banking and lending. In addition to writing, Emily is also a co-host of The Finance Girlies podcast, where she celebrates financial conversations among Millennial and Gen Z women.
