Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing Recourse vs Nonrecourse Loans.
When evaluating different lending options for a piece of commercial real estate, you most likely have heard the terms; recourse, and nonrecourse. In this episode, Charles discusses what the difference is between these two different loan options and why a borrower would choose one over the other.
TALKING POINTS
Charles:
Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing recourse versus non-recourse loans.
Charles:
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Charles:
When looking at financing a commercial property, there are a number of different loan products available, fixing variable rates, fully amateur bridge and agency, just to name a few. When digging into one of these loan products, you will see that they are typically categorized as recourse or non-recourse loans. So what is a recourse loan? Well, a recourse loan is where the borrower is 100% personally liable for the outstanding loan amount. In the event of a default, the lender is able to foreclose or repossess the collateral as indicating the mortgage agreement. If the collateral does not satisfy the loan balance, the lender is now able to seize the borrower’s other assets in income. This could include levying bank accounts and garnishing the wages of the borrower in order to satisfy the remaining loan balance. Credit cards, auto loans hard money loans, short term real estate loans, and most bank loans are recourse loans. An example of a recourse loan would be where a borrower purchases a car for $30,000, takes out a $25,000 car loan, and after a few years default on the payment.
Charles:
With an outstanding loan balance of $20,000, the bank seizes the car and sells it for 15,000. The lender can now go to the court and get a deficiency judgment, allowing the lender to garnish the borrower’s wages in order to collect the remaining $5,000, plus any fees in that the lender is entitled to. Now, what is a non-recourse loan? Well, a non-recourse loan is where in this situation of a borrower default, the lender is only able to seize the loan collateral. Non-Recourse lenders are unable to go after the borrowers, other assets, even in the case of collateral being worse, less than the outstanding loan balance. Now this of course, makes the loan riskier. For lenders. Most non-recourse loans are offered to borrowers with great credit long track records, and where the collateral is not over leveraged. Many commercial real estate loans are non-recourse, including agency loans, Fannie MA and Freddie Mac, and most bridge loans.
Charles:
A side note, if you default on an agency loan, it is difficult to be approved for another one. So some lenders I’ve spoken with say it may take years to be able to be approved. Again, it is possible, but it makes it much more difficult. An example of a non-recourse loan would be where an investor purchases an apartment complex for 2 million, the lender finances 75% of the purchase or 1.5 million, and years later, the borrower defaults on the property with a 1.4 million loan balance, the lender forecloses on the property and sells it to another investor for 1.3 million. The lender is unable to recoup the a hundred thousand dollars remaining loan balance. So what are the pros and cons of recourse loans? So the pros of recourse loans would be easy approval. Since qualifications are hugely less strict, interest rates are typically lower. A con of a recourse loan would be that the lenders able to seize the collateral, if any, and any other assets or income the borrower may have in the case of a default.
Charles:
Now what are the pros and cons of a non-recourse loan? Well, the pros of non-recourse loans are only the asset pledged as collateral is able to be seized. In case of a default, the borrower’s personal assets and other assets are not at risk and income. Now, a lot of these cases, you’ll have income becomes part of it because if someone defaults on something, it’s like a personal credit card. They probably don’t have the money at all, so they’re probably gonna go and try to garnish the wages of that individual. Now, some of the cons of non-recourse loan would be that the borrower may be unable to ever obtain a non-recourse debt from a similar lender. In the future, the borrower’s credit will most likely be negatively affected. In the case of default, the interest rates are typically higher as well for non-recourse loans. Now, there’s a thing called non-recourse carve outs, and this is really important to understand.
Charles:
These are also referred to as bad boy carve outs, and they are a list of carve outs that may result in the borrower or grantor, assuming full or partial recourse for a non-recourse loan. Now, historically, these carve outs would include bad acts such as loan fraud, theft, voluntary bankruptcy. However, over the years, they have started to include acts that would, would not be considered theft or fraud, like failing to pay property taxes or not properly maintaining the property. If you’re thinking of applying for a non-recourse loan, make sure to check the carve outs with your mortgage broker and attorney prior to making a decision in signing. In closing, both recourse and non-recourse loans allow lenders to foreclose or repossess the collateral once the borrower defaults. The difference between the two is once the collateral is seized, lenders of recourse loans are able to go after the assets and income of the borrowers or any other loan guarantor. So like a co-signer with non-recourse loans, the lenders are unable to seize additional assets of the borrower. So I hope you enjoyed. Please remember to rate, review, subscribe, submit comments and potential show topics at globalinvestorspodcast.com. Look forward to two more episodes next week. See you then.
Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar, LLC, exclusively.
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