When you take out a recourse loan, you agree to be personally liable for the debt. That gives the lender recourse to collect money from you if you fail to repay the loan. Personal loans, auto loans, and credit cards are typically recourse loans. Non-recourse loans are less common. Learn the difference and what to expect when you borrow.
What is a recourse loan?
A recourse loan is one where the borrower is personally liable for repayment, and the lender is allowed to go after their assets or income if they violate the loan terms. For example, if a borrower misses several payments on a recourse loan, the lender may have the right to take money directly from the borrower’s bank account or garnish their wages.
A recourse loan can be secured or unsecured. If a recourse loan is secured, the lender will typically seize the collateral first. Note that most recourse loans aren’t called such — they won’t be labeled “recourse personal loan” or “recourse auto loan.” Instead, this is a general loan category that includes multiple loan types — most personal loans, auto loans, credit cards, and some mortgages.
How do recourse loans work?
Once a borrower misses a certain number of payments, depending on loan type, the debt goes into default. At that point, the lender can seize any collateral attached to the loan. If a balance remains or if no collateral was involved, it can get a deficiency judgment to collect the rest of the debt by other means. The lender could even seize your employee bonus, for example, and, in some cases, go after your retirement account.
Good to know
Under the Employee Retirement Income Security Act, many retirement accounts, including employer-sponsored 401(k) plans, are protected from creditors. However, your traditional or Roth IRA could be fair game, depending on your state.
Many people believe that if they offer an asset as collateral, losing the asset will be the worst consequence of failing to repay the debt. But recourse debt allows the lender to do further damage to your financial situation. For example, if the value of your vehicle has depreciated since you signed a recourse auto loan agreement, the lender won’t be able to cover the outstanding debt by selling the car. A recourse loan would allow the lender to take other actions against you.
“Many of the individuals I counsel who have had their vehicle repossessed are surprised and frustrated when the lender sends them a collection notice for the balance of the loan remaining after they sold the vehicle at auction, not to mention innumerable added fees,” says Todd Christensen, author and education manager for MoneyFit.
When are recourse loans used?
Most auto loans, personal loans, and mortgages in many states are recourse loans. To find out if your loan is a recourse loan, check your loan agreement for a statement of personal liability or ask your lender directly. Your loan agreement may indicate the lender’s rights in the event of a deficiency balance.
State laws vary on deficiency judgments. For example, you can find out whether your state laws allow recourse mortgages and under which circumstances a mortgage lender can pursue a deficiency judgment. The legal advice website Nolo.com has a state-by-state database of deficiency judgment laws, although the website points out that its content isn't a substitute for advice from an attorney.
Recourse loan vs non-recourse loan
Editor insight: “The term 'hard money' refers to physical assets. Most hard money loans involve real estate that a borrower intends to buy, with the property serving as collateral and funding typically provided by private investors or non-bank lenders. An example is a 'house flipper' who takes out a hard money loan to buy and renovate a property with the goal of a quick, profitable resale. As with other types of recourse loans, defaulting on a hard money loan could mean the borrower loses the collateral and potentially other assets.”
— Barry Bridges, Personal Loans Editor, Credible
Pros and cons of recourse loans
Pros
- Lower interest rates
- More loan options
- Easier qualification
Cons
- Risk of financial hardship
- Possible credit damage
Pros
- Lower interest rates: Because of the reduced risk to the lender, recourse loans tend to have lower interest rates than non-recourse loans.
- More loan options: Recourse loans are more common than non-recourse loans, so borrowers have more options to choose from.
- Easier qualification: Recourse loans tend to have less stringent eligibility requirements because it’s easier for the lender to recover the funds if the borrower stops making payments.
Cons
- Risk of financial hardship: You could face consequences such as wage garnishment, seizure of your assets, and legal action if you default on a recourse loan.
- Possible credit damage: If the lender gets a deficiency judgment, it can stay on your credit report for up to seven years. Since the lender would have also reported your missed payments, your credit score could take a plunge.
Risks of recourse loans
If you default on a recourse loan, any of the following could happen:
- Seizure of collateral: The lender can take the asset backing the loan and sell it to recover the loan funds.
- Seizure of other assets: If the lender or debt collector obtains a deficiency judgment, they could seize your other assets, even assets not listed in the loan agreement. For example, the lender could place a lien on your home or take money from your pension or retirement account.
- Bank account levy: The lender or debt collector could take money directly from your bank account or freeze your accounts if the court approves a judgment.
- Wage garnishment: Depending on the loan agreement and state law, the lender may take a portion of your wages until the loan is repaid. The lender could also take your commissions or bonuses.
- Credit score damage: The lender can report negative information to the credit bureaus if you default, which would damage your credit score.
- Additional fees: The lender can add additional fees when you don’t repay the loan as agreed, allowing them to collect more money than your outstanding balance.
FAQ
Are all mortgages recourse loans?
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What does signing without recourse mean?
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What is a limited recourse loan?
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Are recourse loans secured?
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