What is a Recourse Loan?
If a loan is recourse, and a borrower fails to repay it, the lender can go after both the collateral as well as the borrower’s assets which were not used as collateral. In comparison, if a loan is non-recourse, a lender is not permitted to seize a borrower’s non-collateral assets.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
Recourse Loans and the HUD 221(d)(4) Loan Program
If a loan is recourse, and a borrower fails to repay it, the lender can go after both the collateral as well as the borrower’s assets which were not used as collateral. In comparison, if a loan is non-recourse, a lender is not permitted to seize a borrower’s non-collateral assets. However, most non-recourse loans are subject to “bad boy” carve-outs, which stipulate that a lender can seize a borrower’s non-collateral assets if they commit certain bad acts, like fraud. Fortunately for borrowers, HUD 221(d)(4) loans are non-recourse, though they do typically have “bad boy” carve-outs.
To learn more about HUD multifamily construction loans like the HUD 221(d)(4) loan, fill out the form below and a HUD lending expert will get in touch.
What is a recourse loan in commercial real estate?
A recourse loan in commercial real estate is a loan that provides the personal guarantee of the person borrowing the money or the person(s) behind the entity borrowing the money. This means that if the borrower defaults on the loan, the lender can seek financial damages from the borrower directly, such as repossessing personal property or garnishing wages from a borrower’s bank account. Recourse loans are typically used when a borrower or borrowing entity is not strong enough on its own, or if the property itself doesn't fall into a category that makes it conventional.
What are the advantages of a recourse loan?
The main advantage of a recourse loan is that lenders will often view the personal guarantee as their confidence in repaying the loan amount, and are more willing to provide better terms on the note. This can be beneficial to savvy borrowers since they can get better terms on the loan.
Another advantage of a recourse loan is that it can enable an investor to borrow more than they would be able to with a non-recourse loan. This is because the debt isn’t tied to the borrower’s income or total assets — as they are with a recourse loan.
Finally, recourse loans can be significantly less complicated for a syndication or partnership. Consider the challenges of non-recourse financing in such a situation: Let’s say three investors pool their resources to finance the acquisition of a shopping center. With a recourse loan, all three investors can be held liable for the loan, which can make it easier to secure financing.
What are the disadvantages of a recourse loan?
The main disadvantage of a recourse loan is that the borrower or borrowers are personally guaranteeing the funding amount against their own assets. This means that if the borrower defaults on the loan, lenders can seek financial damages from the borrowers directly. This can be a risk for borrowers who are not financially strong enough on their own, or if the property itself doesn't fall into a category that makes it conventional. Additionally, recourse loans may not offer the same terms as non-recourse loans, such as lower interest rates or higher loan amounts relative to the property value.
For more information, please see Is Non-Recourse Financing Right for You? and What are Recourse Loans?.
What are the requirements for obtaining a recourse loan?
In order to obtain a recourse loan, the borrower or borrowing entity must provide a personal guarantee of the loan amount against their own assets. This ensures that should the borrower default on the loan, lenders can seek financial damages from the borrowers directly. Generally, recourse is more commonly required when a borrower or borrowing entity is not financially strong enough on its own, or if the property itself doesn't fall into a category that makes it conventional. For example, hard money loans are typically full recourse.
What are the differences between recourse and non-recourse loans?
At its core, the difference between the two types is relatively straightforward: 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.
Nonrecourse lenders are typically far more selective, generally opting to finance stronger, lower-risk properties with one eye fixed on a market’s overall strengths and outlook. For example, the owner of a stabilized Class A multifamily property in Manhattan may have little trouble landing a nonrecourse loan, but a first-time investor seeking a hotel refinance in suburban Boise, Idaho, would likely have little choice but to look to recourse financing.
What are the risks associated with a recourse loan?
When taking out a recourse loan, it is important to understand the potential liabilities that could arise. Recourse loans are typically more risky for borrowers, as lenders may pursue a borrower’s personal assets in the event of default. This means that if the collateral is insufficient to cover the outstanding loan amount, a lender could attempt to recover losses by going after a borrower’s personal assets, including wages. It is therefore essential that borrowers understand their personal liability and exposure when taking out a recourse loan. Additionally, borrowers should be aware that certain activities, such as fraud or misrepresentation of financial strength, could trigger a bad boy carve-out, which would allow the lender to pursue recourse options. Knowing the potential liabilities associated with a recourse loan is critical for any borrower looking to explore their commercial real estate finance options.Sources: Apartment Loans Multifamily Loans