What is a Non-Recourse Loan?
If a loan is non-recourse, a lender can take possession of assets used as collateral to secure the loan. However, unlike a recourse loan, if money is still owed after selling the collateral, with a non-recourse loan, the lender cannot go after the borrower’s other assets or garnish wages. The lender must accept the loss.Better Financing Starts with More Options$1.2M offered by a Bank at 6.0%$2M offered by an Agency at 5.6%$1M offered by a Credit Union at 5.1%Click Here to Get Quotes
Non-Recourse Loans and the HUD 221(d)(4) Loan Program
If a loan is non-recourse, a lender can take possession of assets used as collateral to secure the loan. However, unlike a recourse loan, if money is still owed after selling the collateral, with a non-recourse loan, the lender cannot go after the borrower’s other assets or garnish wages. The lender must accept the loss. HUD 221(d)(4) loans are fully non-recourse; however, most have “bad boy carve-outs,” which means that the loan will become recourse if the borrower violates certain loan provisions, including committing fraud or significantly misrepresenting their assets.
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What is a non-recourse loan in commercial real estate?
A non-recourse loan in commercial real estate is a type of loan where the lender is only able to pursue the collateral of the loan in the event of a default. This means that the lender cannot pursue the borrower’s personal assets or wages in the event of a default. To qualify for a non-recourse loan, borrowers must meet certain conditions, such as higher credit scores and more experience in commercial real estate investing. Lenders may also set more stringent debt service coverage ratio requirements and cap leverage at a certain amount.
What are the benefits of a non-recourse loan?
The primary benefit of non-recourse loans is that they provide a greater degree of protection for the borrower. Without a personal guarantee, the lender cannot seize the borrower's personal assets if they default on the loan. This can be especially beneficial for developers who are just starting out and don't have a lot of assets to protect.
Advantages of Non-Recourse Loans for Borrowers include the lack of any personal liability, the ability to borrow more, and the potential for less complicated syndication or partnership.
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What are the risks associated with a non-recourse loan?
The main risks associated with a non-recourse loan are tied to the loan terms a borrower can receive. Because the risks to a lender are higher than with recourse debt, a lender will typically pass this on in the form of higher interest rates, or lower loan amounts relative to the property value to offset the risk. This typically makes non-recourse financing more expensive.
Another potential risk is tied to exceptions to the non-recourse clause in the loan. While it’s true that a lender generally cannot pursue a borrower’s personal assets or income outside of the property itself, most non-recourse loans include language for what are known as bad boy carve-outs. These provisions essentially state that, should the borrower misrepresent a property or themselves, or file fraudulent financial documents — like tax returns or financial statements — the borrower is no longer protected by the non-recourse clause and is fully responsible for the loan. They may also cover other acts, such as raising subordinate financing when it’s not allowed, or even paying real estate taxes late.
What types of commercial real estate properties are eligible for a non-recourse loan?
Non-recourse loans typically accept certain property types and classes, such as Class A office or multifamily properties in major MSAs (i.e., New York or Los Angeles). Property income, both past and present, is also a determining factor, as well as the requested amount of leverage. In general, non-recourse loans typically have a higher interest rate than their recourse counterparts. Source
Lenders will typically set more stringent debt service coverage ratio requirements and may cap leverage at a certain amount. Source
What are the requirements for obtaining a non-recourse loan?
In order to qualify for a non-recourse loan, commercial lenders often have strict eligibility requirements. Most non-recourse programs can only be utilized for the financing of certain property types and classes, such as a class A office or multifamily property in a major MSA (i.e. New York or Los Angeles). The income that a commercial property produces (both past and present) is also a determining factor. Additionally, lenders tend to analyze the requested amount of leverage. Non-recourse commercial mortgage loans tend to have higher interest rates than their recourse counterparts, and are also generally only available to borrowers that have a very strong financial profile. Lenders can be pretty strict about this, the thought process being that a default is significantly less likely in this scenario because the borrower has the financial means to make sure that the property’s income is reinvested into the property. Aside from strong finances, commercial mortgage lenders also require a very experienced borrower with ample "skin in the game" for non-recourse financing.
How does a non-recourse loan differ from a recourse loan?
Non-recourse loans differ from recourse loans in that if a borrower defaults on a recourse loan, a lender can pursue the borrower’s personal assets — even wages — if the collateral is insufficient to cover the outstanding debt. With a nonrecourse loan, the lender is limited to the collateral itself to recoup losses.
Typically, most bank, bridge and construction loans are recourse, while Fannie® Mae®, Freddie® Mac®, HUD/FHA multifamily and CMBS loans are generally nonrecourse — though exceptions are not rare.
Because of the difference in risk to borrowers and lenders, there are some key differences in loan terms and requirements. In brief:
Recourse Loan Nonrecourse Loan Risk Profile Riskier for borrowers Riskier for lenders Default Event Lenders may pursue a borrower's personal assets Lenders may generally only pursue a loan's collateral. Borrower Profile Typically less experienced More experienced, financially stronger Interest Rate Generally lower Generally higher Asset Types Any Often restricted to "strong" assets and locations LTV Generally higher Generally lower Examples Most bank loans, bridge loans, construction loans Most Fannie Mae®, Freddie Mac®, CMBS loans
While borrowers broadly prefer nonrecourse financing, lenders favor recourse loans due to lower risks. Due to this imbalance, these types of loans tend to have rather different terms associated with them.