What Is a Recourse Loan?

Understanding recourse loans

A recourse loan is a type of loan that holds a borrower personally liable for debt. It allows a lender to seize your assets if you default on your loan.

This is different from a secured loan, which uses one form of collateral, because a recourse loan lets a lender pursue other assets, even those not listed in the loan agreement. If the total amount you owe is more than the collateral you put up for your loan, the lender can legally seize other assets, such as your home, car or boat, to make up the difference. It can also potentially garnish your wages or seize the contents of your savings account.

Because there’s a lower risk for the lender, it can be easier to qualify for a recourse loan, and interest rates are often lower than those of an unsecured loan. These lower interest rates may make recourse loans attractive to borrowers, but the higher risk may not be worth it if you feel like you may be unable to meet the terms for repayment in the future.

Recourse vs. nonrecourse loans

A nonrecourse loan is similar to a recourse loan, but there are limits on what the lender can take. Lenders may only seize the assets specifically itemized in the loan agreement. If the assets aren’t enough to satisfy the outstanding loan balance, the lender won’t be able to seize your other assets, unless they are mentioned in the loan agreement.

“A nonrecourse loan limits the lender’s recovery to the collateral only,” said Chris Natale, managing principal at Diversified Commercial Capital in Scottsdale, Arizona. “If the borrower defaults and the sale of the collateral doesn’t cover the full balance, the lender cannot pursue the borrower personally for the deficiency.”

Because nonrecourse loans present a higher risk of loss to the lender, interest rates are generally higher than those of a recourse loan. Credit requirements are also typically stricter, often requiring excellent credit to qualify.

Many banks today no longer offer nonrecourse loans, making them harder to find. A personal loan is a popular option for those who need cash but want to avoid risking other assets.

Types of recourse loans

There are several types of recourse loans available.

• Car loan: Most auto loans are recourse loans with your car serving as collateral. If you default on your loan, the lender can repossess the vehicle. However, due to depreciation, the lender may not get enough to settle the entire debt. It may then choose to seize your other assets to satisfy the balance.
• Mortgage loan: Most mortgages are recourse loans, with the property serving as collateral. However, this can depend on your state law.
• Personal loan: The majority of personal loans are unsecured, but a few are recourse loans, meaning a lender could sue to collect from other assets if you default. Be sure to check the loan terms before signing.
• Credit cards: Depending on your credit card agreement, a lender could sue and obtain a judgment to seize assets if you fail to pay your bill.

Before you take on new debt, be sure to carefully review the loan agreement so you fully understand what happens if you go into default.

Pros and cons of recourse loans

Recourse loans can be easier to qualify for and cost less than other options, but the trade-off is a higher risk to your personal assets.

Recourse loans are an attractive option for borrowers looking for a low interest rate or those with imperfect credit. Because the borrower shoulders most of the risk, they can also be easier to qualify for with more flexible loan requirements.

However, this type of loan carries greater risk than a nonrecourse loan because it leaves your assets vulnerable if you’re unable to make your payments in the future. If you fail to make your mortgage payments, you could end up not only losing your home but perhaps your car, too.

Before accepting the terms for a new loan, carefully review the agreement to ensure you fully understand whether your assets are at risk.

Legal considerations and state variations

Ultimately, the rules of a recourse loan depend on where you live, as state laws can vary. There are 12 nonrecourse states, meaning lenders can only claim the collateral listed in the loan agreement. These states are:

• Alaska
• Arizona
• California
• Connecticut
• Idaho
• Minnesota
• North Carolina
• North Dakota
• Oregon
• Texas
• Utah
• Washington

If you don’t live in one of these states, a lender may be able to treat your loan as a recourse loan. In this case, the lender will obtain a deficiency judgment. This is generally limited to an asset’s fair market value, so the lender can't unfairly overvalue an asset to collect a larger balance. Certain states, such as Arizona and California, limit when a deficiency judgment can be used.

Check your state’s laws before you borrow

Whether your loan is recourse or nonrecourse often depends on state law. Knowing your state’s rules can help you understand how much of your property is at risk if you default.

“Recourse rights and deficiency judgments vary significantly by state,” said Natale. “Nonrecourse states, such as California and Arizona, limit a lender’s ability to pursue deficiency judgments on purchase-money loans (loans used to acquire the property). Other states differ on whether and how lenders can pursue borrowers for deficiencies after foreclosure.”

In some cases, filing for bankruptcy can help if you have debt you can't pay. However, it's best to consult a lawyer who can advise you on state law so you know exactly what a debt collector can do.