What Is Non-Recourse Lending?
Non-recourse lending is a route for borrowers who risk their collateral rather than the possibility of legal ramifications. Below, learn about the various aspects of non-recourse lending, how it differs from a regular loan, and more.
What Is Non-Recourse Lending?
Non-recourse lending is where the lender does not have the right to pursue the borrower for losses from the loan.
In non-recourse lending, the lender's recourse is the agreed-upon collateral. This means the borrower pledges something as collateral, often the property being bought. In case of default, the lender gets the property but cannot pursue legal action against the borrower.
Example of a Non-Recourse Loan
Non-recourse loans often involve the loan being used for a purchase, such as a mortgage or an automotive loan. In these circumstances, the lender will receive the house or car if the borrower defaults. Not all loans are non-recourse, as it depends on the lender, loan type, and terms and conditions.
Advantages of Non-Recourse Lending
- Non-recourse lending lowers personal liability, which means lower risk to the financial well-being of the borrower.
- It often means more favorable stipulations, such as longer loan terms and lower down payments.
- For business assets, it allows the owner to finance real estate or equipment without jeopardizing their personal assets.
Disadvantages of Non-Recourse Lending
- Non-recourse lending may mean higher interest rates because the lender takes on more risk.
- The limited collateral means the funds are more limited than that of a recourse loan.
- Non-recourse loans do not build credit scores.
Recourse Loans vs. Non-Recourse Loans
In a recourse loan, if a default occurs, the lender can pursue the borrower’s assets if the pledged collateral has been liquidated and there is still money owed. With a non-recourse loan, the lender can take the pledged collateral, and not pursue the assets.
Recourse loans provide more security for the lender, so they often have lower interest rates, while non-recourse loans provide more security for the borrower.
Types of Non-Recourse Lending
There are two types of non-recourse lending: secured and unsecured. Secured is used to purchase something, which is then collateral, such as a car, house, or large piece of machinery. Unsecured non-recourse loans have no collateral, such as personal and student loans.
Secured Non-Recourse Lending
In secured non-recourse lending, the collateral is considered. The security of the lender lies in the value of the asset, and the asset is the buyer's bargaining chip for acquiring favorable terms and conditions.
Unsecured Non-Recourse Lending
In unsecured non-recourse lending, the buyer's financial history and credit score are two factors. Because the lender cannot recover their money if the borrower defaults, these loans are often given to individuals with high credit scores and a stable financial history.
Qualifying for Non-Recourse Lending
Several qualifying factors lenders consider. Credit score, collateral, and documentation are the main categories of qualifiers. When examining a potential non-recourse loan, lenders look for the most security for their investment, which is why all three ranks are important.
Credit Score Requirements
Lenders require a good to excellent credit score for a non-recourse loan. Because the collateral is not always worth as much, the lenders need assurance that a default is improbable. A good credit score shows that the borrower has a good history of making full payments on time. If the collateral is a valuable asset, it may mitigate the credit requirements.
Lenders pursue non-recourse lending with assets that have potential value in case of default. “Fixer-upper” houses, used cars, and other assets that require repairs will also be riskier, so it may be tough to secure a non-recourse loan.
Lenders will require several documents, and it helps to have these on hand. These include w2s, pay stubs, tax returns, a valid I.D., and other legal and financial documents. All creditors have different requirements, so consult the lender at the beginning of this process.
Regulations Surrounding Non-Recourse Lending
The requirements vary depending on the state, jurisdiction, and loan type. Non-recourse lending is standardized by federal and local governments. The I.R.S. has rules around taxing and more rules if an I.R.A. is involved. Read more about the regulations in IRS’s report.
Risk Mitigation Strategies for Non-Recourse Lending
For the buyer, the risk has already been mitigated by the nature of it being a non-recourse loan. Lenders mitigate the gamble through a few strategies. Lenders research the qualifications of the borrower and the collateral. They must have a favorable L.T.V. (loan-to-value ratio). The lender may also require covenants, third-party guarantees, and the borrower to insure the asset.
Other Potential Uses for Non-Recourse Lending
There are several possible options. A business can acquire necessary assets. They could be used to purchase commercial real estate because that collateral almost guarantees the lender will not lose money. Non-recourse loans may also be used to purchase equipment or high-end electronics.
The Bottom Line
Non-recourse lending can be ideal for buyers mitigating risk. It is a good option to purchase something valuable. It often has higher interest rates but can be worthwhile to secure more favorable terms.
Contact a Wesley Mortgage representative today to learn more about your lending options or if you need help in other ways during your homeownership journey!