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What’s the difference between recourse and non-recourse loans?
23 Nov 2021
If you take out a loan, it will often be ‘secured’ by an asset – something you own of value. This asset will be considered collateral, and the lender will have the right to seize it and sell it to recoup the money owed to them in the event you are unable to meet your loan repayments.
Within this framework, though, there are two different types of loans – recourse and non-recourse. So how do they work, and what is the difference?
what-is-a-non-recourse-loan?">What is a non-recourse loan?
A non-recourse loan is a type of loan that is secured only by the assets that have been put up for collateral, and nothing more. This means that if the borrower defaults on their loan, the lender has the right to seize whatever asset was put up as collateral and sell it, but they cannot seek further compensation from the borrower or seize any more of the borrower’s assets.
How does a non-recourse loan work?
Say, for example, a borrower takes out a loan of $10,000, and puts up a $5,000 car they own as collateral. If the borrower pays off only $1,000 of the loan and then defaults, the lender will have the right to seize the car, which was put up as collateral, and sell it, but they cannot seek any further money to cover their losses.
In this situation, if the lender successfully sells the car for $5,000, they will still be owed $4,000, but they will have no legal right to seize any of the borrower’s other assets in order to make up this shortfall. For this reason, non-recourse loans are risky for borrowers, and can come with higher fees and interest rates, if they are offered at all.
what-is-a-recourse-loan? ">What is a recourse loan?
A recourse loan is a type of loan that is secured by the assets that have been put up for collateral, but in the event that the sale of these assets is not enough to cover the debt owed, the lender will have the right to pursue the borrower’s additional assets or take legal action against them in order to recoup their losses.
How does a recourse loan work?
Say, for example, a borrower takes out a loan of $10,000, and puts up a $5,000 car they own as collateral. If the borrower pays off only $1,000 of the loan and then defaults, the lender will have the right to seize the car, which was put up as collateral, and sell it, but the lender’s right to pursue the borrower would not end there.
Say, as in the above example, the lender sold the car for $5,000 but was left with a debt of $4,000 still to recover. The lender would have various options open to them, such as pursuing the borrower’s other assets beyond the collateral, and even potentially suing to have the borrower’s wages garnished to recoup the debt.
From a lender’s point of view, recourse loans are less risky than non-recourse ones, and so for this reason, you might expect them to come with lower interest rates and fees.
can-you-get-a-non-recourse-loan-in-australia?">Can you get a non-recourse loan in Australia?
Non-recourse loans are rare for individual borrowers in Australia, and it may be unlikely you will find a lender who offers them, as they are typically only offered to commercial borrowers. Recourse loans are the most common kind in Australia – all residential loans are recourse loans, for example, and if you take one out, your house will be collateral against the loan.
what-is-a-limited-recourse-loan?">What is a limited-recourse loan?
A limited-recourse loan is similar to a non-recourse loan, but has narrower and more specific rules about how and when it can be taken out. According to the Australian Tax Office (ATO), a limited-recourse borrowing arrangement (LRBA) is when a self-managed super fund (SMSF) trustee takes out a loan from a third party lender and uses it to purchase a single asset, or a collection of identical assets with the same market value, which are held in a separate trust. Returns on the investment on this asset go to the SMSF trustee, and if the loan defaults, the lender has the right to sell the assets held in the trust, but none of the other assets held by the SMSF.
Cover image source: fizkes/Shutterstock.com
This article was reviewed by our Sub Editor Jacqueline Belesky and Finance and Lifestyle Editor Shay Waraker before it was updated, as part of our fact-checking process.
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