What is nonrecourse debt?
If you default, the lender can seize the collateral — and nothing further
When you have a nonrecourse debt, your assets, except the collateral, are protected if you default on the loan. For example, if you default on a mortgage that is a nonrecourse debt and you owe more than the house is worth, the lender can take the home (the collateral), but can’t come after any other assets to cover the deficiency.
This type of loan is riskier for lenders, so there are usually stricter credit score and loan-to-value ratio requirements. State laws may determine if your loan is a recourse or nonrecourse debt.
- If you default on a nonrecourse loan and the collateral doesn’t cover the amount owed, the lender can’t pursue further action to collect the money.
- Nonrecourse loans present higher risk to a lender, so they have stricter eligibility requirements.
- States law may determine whether a loan is a recourse or nonrecourse debt.
Nonrecourse debt vs. recourse debt
The key difference between recourse and nonrecourse debt is what the lender is allowed to take if you default on the debt. For a nonrecourse debt, a lender can only seize the collateral to compensate for the unpaid loan. A recourse debt allows the lender to pursue other assets besides the collateral if the loan balance isn’t covered.
Home loans are nonrecourse in Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah and Washington.
The risk to you, the borrower, is smaller with a nonrecourse debt because the collateral is the only asset at stake.
“If you get into hot water, you're only liable for the collateral and the debt won't follow you,” explained Jake Hill, CEO of DebtHammer, a debt relief company in Austin, Texas.
The risk to the lender is greater with a nonrecourse loan. Many lenders don’t offer nonrecourse loans. Those that do tend to require excellent credit scores, and they typically charge higher interest rates.
Keep in mind that just because it is less risky to you doesn’t mean there aren’t negative consequences for defaulting on a nonrecourse debt. “If you default on a nonrecourse loan, your collateral is forfeited,” Hill said. “So if you offered up your home as collateral, the lender will own it.”
- Can’t lose more than collateral if you default
- Requires higher credit score, lower LTV ratio
- Higher interest rate
When you take on a recourse debt, you are assuming full liability of the debt, including any deficiency left over after the collateral is seized. This means the lender may have the right to, for example, levy accounts or garnish wages to recover loan funds. A recourse loan is therefore less risky for the lender than a nonrecourse loan.
- Less strict eligibility requirements
- Lower interest rate
- Riskier for the borrower
Examples of recourse debt
Recourse loans are more widely available than nonrecourse loans because they are less risky for the lender. If you apply for a car loan or mortgage, it is likely a recourse debt unless you live in a state that requires nonrecourse loans.
Auto loans are recourse loans. Say you buy a new car for $40,000 that depreciates 20% in value over the first year. After 12 months, your principal balance on the loan is $35,000, and you suddenly have trouble making your car payment: You have an asset that’s worth $32,000, less than what you owe. With an auto loan, the lender can seize both the vehicle and take action to collect the remaining $3,000.
Home loans (usually)
Mortgages in most states are recourse loans. However, there are 12 states that legally require home loans to be nonrecourse, including Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah and Washington.
In a nonrecourse mortgage, if you default, the lender can only seize the property that secures the loan, even if its value has fallen below the outstanding loan balance. In most states, however, the lender can go after any balance that remains after the sale of the home. It does this by, for instance, pursuing a deficiency judgment from a court, which gives the lender the legal right to collect the remaining debt.
What happens when you don’t pay back a loan?
You should always attempt to pay any debts you owe. If you default on a loan, the implications are different for recourse and nonrecourse debts.
|Lender seizes collateral|
|Credit negatively affected|
|Lender can take legal action to collect deficiency|
|Forgiven deficiency is possibly taxable|
Daniel, a borrower from Louisiana, defaulted on a recourse loan and faced wage garnishments, he told ConsumerAffairs. He eventually reached out to a debt relief company for help.
“I was worried about how I was going to make ends meet, and I was scared about what would happen if I didn't pay my debt back,” he said. “I knew I needed to do something. … Thankfully, it did work, and I was able to get my debt forgiven. It was such a relief to be free of that weight.”
- Are there laws to protect borrowers?
The Truth In Lending Act is one of the main laws that protect those who use consumer credit, like mortgage loans and personal loans. It requires lenders to provide specific information that makes it easier to comparison shop:
- Annual percentage rate (APR)
- Total finance charges
- Amount financed
- The total of all payments
- Late fees
- Interest rate increases
- Service charges and fees
Another law that protects consumers is the Fair Debt Collection Practices Act, which prohibits debt collection companies from using unfair, abusive or deceptive methods to collect debt, like contacting you before 8 a.m. or after 9 p.m.
- Are there tax implications if a lender writes off a portion of my debt?
If you have a recourse loan and any of the debt is forgiven, that amount may be considered taxable income. It’s a good idea to speak with a tax professional and describe your specific situation so you know if the canceled debt adds to your tax liability.
- What can you do if you can’t pay off recourse debt?
If you are facing trouble paying a debt, it’s best to act quickly. In some cases, you can come to an agreement with the creditor. Some resolutions include:
- Forbearance: A creditor may allow a pause or reduction in payments for a certain amount of time to allow you time to resolve financial problems.
- Loan restructuring: A lender may agree to change the terms of your loan, such as by lowering the interest rate or extending the term.
If you’re uncomfortable doing these negotiations, you could contact a credit counseling organization or a debt relief company.
- Article sources
- ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. To learn more about the content on our site, visit our FAQ page.
- IRS, “Recourse vs. Nonrecourse debt.” Accessed June 17, 2022.
- Office of the Comptroller of the Treasury, “Truth in Lending.” Accessed June 17, 2022.
- Consumer Financial Protection Bureau, “Are there laws that limit what debt collectors can say or do?” Accessed June 17, 2022.
You’re signed up
We’ll start sending you the news you need delivered straight to you. We value your privacy. Unsubscribe easily.