The Difference Between Recourse and Nonrecourse Loans: How You Can Save Money

Loans can occur as either recourse, or nonrecourse debt and how it's classified can have a significant impact on a borrower's financial future.

What you should know

If a loan amount is secured by property such as a house and the borrower defaults, the lender is entitled to the property as repayment for all or a portion of the loan amount. 

Whether the loan is classified as recourse or nonrecourse will determine whether the lender is legally allowed to pursue repayment of the loan beyond the value of the collateral secured by the loan.

Suppose the house that secures the loan is only worth half of the total loan amount at the time that the borrower defaults. If the loan is a recourse loan, the lender can attempt to gain back the remainder of the debt from the borrower in other ways, such as lawsuits or wage garnishment. 

If the loan is a nonrecourse loan, however, the lender is not permitted to pursue further repayment. He or she is left with only the value of the house and must write off the remainder of the debt as a loss.

To recap: recourse loans allow the lender to pursue additional repayment beyond the collateral that secures the loan. Nonrecourse loans do not allow this--the lender may collect only the value of the collateral.

Considerations

Failure to pay off a loan will affect your credit score in the same way regardless of whether the loan is recourse or non-recourse. Typically, nonrecourse loans are reserved for borrowers who have high credit scores and low risk.

Whether a home loan or mortgage is classified as recourse or nonrecourse depends on:

• the state in which the property is located
• the state in which the loan is taken out
• whether the loan money will be used to purchase a home or to refinance one
• most importantly, what the lender stipulates in the loan agreement.

If you compare mortgage rates between recourse mortgages and non-recourse mortgages, you'll find that rates for nonrecourse mortgages are almost always higher. 

Nonrecourse loans are considered to be riskier for lenders than recourse loans. Keep this in mind as you're preparing for a home purchase. This classification can affect the rates that different lenders offer. Check with your lender to ensure that you're able to get the loan type that you need.

Gretchen Wegrich

Gretchen Wegrich is an editor at Lender411. She specializes in mortgage basics, personal finance and green living. She graduated with a bachelor's degree in writing from University of California, San Diego and previously worked at the Santa Cruz Sentinel. Contact her at gretchen@lender411com.