Recourse vs. Non-Recourse Loans: What’s the Difference?

When borrowing money for real estate, one of the most important factors to consider is whether the loan is recourse or nonrecourse. If things don’t go as planned, this decision affects your personal liability, interest rates, and financial risk.

A recourse loan allows the lender to claim personal assets if the collateral (like a property) doesn’t fully cover the outstanding debt. A nonrecourse loan, on the other hand, limits the lender’s ability to recover losses—meaning they can only take the collateral and nothing more.

Choosing between these two types of loans depends on your financial situation, investment goals, and risk tolerance.

Let’s break down how they work, their key differences, and what you should consider before taking one out.

---

---

What Is a Recourse Loan?

A recourse loan gives lenders the right to seize both the collateral and the borrower’s personal assets if the loan balance isn’t fully repaid. This means that in the event of default, lenders can go after bank accounts, investments, wages, and other properties.

Recourse loans are generally easier to qualify for because they provide lenders with multiple ways to recover losses. As a result, borrowers often get lower interest rates and higher loan-to-value (LTV) ratios, allowing them to borrow more against the value of the property.

However, the trade-off is greater financial risk since personal assets are on the line if the property’s value drops or if the borrower is unable to make payments.

What Is a Nonrecourse Loan?

A nonrecourse loan limits the lender’s recovery options to the value of the collateral. If the borrower defaults, the lender can only seize the property securing the loan, even if its value doesn’t fully cover the remaining debt.

Because lenders face a higher risk with nonrecourse loans, they typically charge higher interest rates and set stricter borrower qualifications. Borrowers must often show a strong credit history, stable income, and high-value collateral to qualify.

While this type of loan protects personal assets, it also comes with tighter lending terms and more conservative loan amounts.

Example: How Recourse and Nonrecourse Loans Work

Imagine you take out a $500,000 loan to buy a commercial property. Later, due to a market downturn, the property’s value drops to $400,000, and you default on the loan.

• If it’s a recourse loan, the lender forecloses on the property, sells it for $400,000, and then sues you for the remaining $100,000. They may garnish your wages, freeze bank accounts, or seize other assets to recover the difference.
• If it’s a nonrecourse loan, the lender can only take the property and sell it for $400,000. They cannot go after your personal assets for the remaining $100,000 loss.

Why Do Nonrecourse Loans Have Higher Interest Rates?

Lenders charge higher interest rates on nonrecourse loans because they face greater risk. Since they can’t recover outstanding debt beyond the collateral, they compensate by increasing borrowing costs.

To minimize their risk, lenders also impose lower loan-to-value (LTV) ratios, which means borrowers must put down a larger down payment.

Additionally, the approval process for nonrecourse loans is more rigorous, requiring higher credit scores and detailed financial documentation to ensure the borrower is financially stable.

Reviewing the Loan Agreement

Your loan agreement will specify whether a loan is recourse or nonrecourse. It’s crucial to understand what happens in case of default and whether the lender can pursue your other assets.

In some states, laws restrict lenders from converting nonrecourse loans into recourse loans.

However, many nonrecourse agreements include “bad boy carve-outs,” allowing the lender to recourse the loan if the borrower commits fraud, misrepresents financials, or intentionally damages the property.

Common Types of Recourse and Nonrecourse Loans in Real Estate

Recourse loans are commonly used in traditional bank loans, construction loans, and bridge loans. These loans are easier to obtain and offer lower interest rates, but they put more financial responsibility on the borrower.

Nonrecourse loans, on the other hand, are more frequently found in government-backed financing programs such as HUD, Fannie Mae, and Freddie Mac.

Related: Agency Loan vs. Non-Agency Loan: Which Is Right for You?

Some commercial real estate loans also offer nonrecourse terms, particularly when the borrower has a strong financial profile, and the property has a solid cash flow.

Risk Assessment: When Should You Choose a Recourse or Nonrecourse Loan?

A recourse loan is best for borrowers who prioritize lower interest rates and don’t mind taking on more personal liability. These loans allow for higher LTV ratios, meaning you can borrow more against the value of your property. If you have strong cash flow and a stable financial situation, a recourse loan may provide better terms and flexibility.

On the other hand, nonrecourse loans are ideal for real estate investors who want to protect personal assets in case of a market downturn. If you’re financing a high-value commercial property, a nonrecourse loan can shield your other assets from risk. However, expect stricter qualification requirements and higher interest rates as lenders compensate for their limited ability to recover losses.

Understanding Deficiency Judgments in Recourse Loans

If a borrower defaults on a recourse loan, lenders may file a deficiency judgment—a legal action allowing them to collect the remaining balance after selling the collateral.

For example, if a property sells for $300,000 but the loan balance was $350,000, the lender can sue for the remaining $50,000. In contrast, nonrecourse loans do not allow lenders to pursue borrowers for unpaid debt after foreclosure.

Factors to Consider Before Taking Out a Loan

Before signing a loan agreement, consider your financial situation, risk tolerance, and long-term investment goals.

• If you have substantial assets and can handle some risk, a recourse loan may offer better borrowing terms.
• If protecting personal wealth is your top priority, a nonrecourse loan might be the better choice, even with its higher costs.
• The type of property you’re financing also matters. Some commercial real estate loans automatically qualify for nonrecourse terms, while residential mortgages are more likely to be recourse loans unless state laws say otherwise.

Final Thoughts: Choosing the Best Loan Option

Both recourse and nonrecourse loans play a role in real estate financing. If you’re looking for lower interest rates and easier approval, a recourse loan might be the better fit. However, if asset protection and financial security are your priorities, a nonrecourse loan could be worth the higher cost.

Always review the loan terms carefully and consider consulting a financial advisor to ensure you choose the best option for your investment strategy.

FAQs

What are the primary differences between recourse and nonrecourse loans?

The main difference between recourse and nonrecourse loans relates to lender rights after default. With recourse loans, lenders can pursue borrowers personally for any remaining balance after liquidating collateral.

Nonrecourse loans limit the lender’s recovery to only the collateral securing the loan. If you default and the property value doesn’t cover the debt, the lender cannot pursue your other assets.

Interest rates on nonrecourse loans are typically higher than recourse loans because lenders face greater risk. This risk premium compensates lenders for their limited recovery options.

How does a nonrecourse loan affect my partnership basis?

Nonrecourse debt increases all partners’ tax basis in the partnership. Unlike recourse debt that only affects partners bearing economic risk, nonrecourse loans are allocated across all partners.

Your share of nonrecourse liabilities is typically allocated based on your profit sharing percentage in the partnership. This allocation impacts your ability to receive tax-free distributions and deduct losses.

When nonrecourse debt exceeds the basis of partnership assets, special allocation rules apply to prevent artificial tax losses.

What are the tax implications of recourse vs nonrecourse debt?

With recourse debt, you may face potential cancellation of debt income if the lender forgives any portion after liquidating collateral. This can trigger ordinary income tax liability.

Nonrecourse debt forgiveness is treated differently. When property is foreclosed, the transaction is treated as a sale for the full loan amount, potentially resulting in capital gains rather than ordinary income.

Partnership recourse liabilities affect partners who bear economic risk, while nonrecourse liabilities are allocated according to partnership agreement terms and IRS regulations.

In what scenarios would a lender opt for a recourse loan over a nonrecourse loan?

Lenders prefer recourse loans for riskier borrowers or transactions where collateral value is uncertain. New businesses or startups often face recourse requirements due to limited operating history.

Smaller loan amounts typically come with recourse provisions because the administrative costs of foreclosure would be disproportionate to potential recovery.

Projects with uncertain cash flows or properties in volatile markets usually require recourse provisions to protect lender interests.

Are personal guarantees required for nonrecourse debt?

Standard nonrecourse loans don’t require personal guarantees for the entire loan amount. The borrower’s liability is strictly limited to the collateral property.

However, many “nonrecourse” loans include carve-out guarantees for specific actions like fraud, waste, or environmental damage.

These are sometimes called “bad boy” guarantees. These limited guarantees convert nonrecourse debt to recourse debt only if specific conditions occur. This gives lenders some protection while maintaining the nonrecourse nature under normal circumstances.

How is qualified nonrecourse financing treated differently from nonrecourse financing?

Qualified nonrecourse financing receives special tax treatment under IRS rules.

This specific type of financing allows real estate investors to deduct losses that exceed their actual investment.

To qualify, the loan must be secured by real property, obtained from a qualified lender like a bank, and not guaranteed by any partner. Government loans may also qualify.

This special treatment helps real estate investors benefit from tax deductions while using leverage, making it particularly valuable for commercial real estate investments.