Nonrecourse Loans Explained

Q: How do I qualify for a nonrecourse loan?

You may need excellent credit, steady income, and a low debt-to-income ratio to qualify for a nonrecourse loan. Your debt-to-income ratio, also known as DTI, measures your ability to afford new debt without defaulting on your existing obligations. Most lenders like to see a DTI below 36%.

Q: Why use a nonrecourse loan?

A nonrecourse loan is a source of financing that can help borrowers realize their goals. A nonrecourse loan, for example, may help you buy your first home. Another reason why a consumer may consider using a nonrecourse loan is to potentially be shielded from personal liability in the event of default.

Q: Are you required to repay a nonrecourse loan?

Yes, you are generally required to repay a nonrecourse loan in accordance with the terms and conditions of the loan agreement. Lenders may seize your collateral if you default on the loan. Your credit score may also plunge if you default on a nonrecourse loan. A nonrecourse loan may shield you from personal liability in the event of default, but failing to repay the loan in full may still invite undesirable consequences.

Sulaiman Abdur-RahmanUpdated October 15, 2023

Share this article:

Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

Nonrecourse loans are collateralized financial lending products that restrict how a lender can respond if you default on the loan. A nonrecourse loan is always secured by collateral, which can include real estate or any other asset that you own.A nonrecourse loan permits the lender to seize your collateral if you default on the loan. The lender, however, is generally restricted from taking any further action. That means the lender cannot hold you personally responsible if the outstanding balance on your defaulted loan is greater than the market value of your collateral.Here, we’re taking a closer look at nonrecourse loans, including how they work, how to qualify for one, the differences between recourse and nonrecourse loans, and more.

What Are Nonrecourse Loans?

As mentioned above, a nonrecourse loan is a secured lending product that restricts how a lender can respond if you default on the loan. In the event of default, the lender can seize the asset that was put up for collateral but cannot take any further action.Certain consumer loans — including secured personal loans, mortgage loans, and auto loans — may fall under the nonrecourse loan definition. Any loan agreement secured by collateral and featuring binding nonrecourse provisions is a nonrecourse loan.

Recourse vs Nonrecourse Debt

Both recourse loans and nonrecourse loans are secured forms of debt, meaning they are backed by collateral. With a nonrecourse loan, the lender can only take the asset put up for collateral if you default. With a recourse loan, the lender can seize other assets in addition to the collateral if you default and owe more than your collateral is worth.Recommended: What Can Be Used as Collateral for a Personal Loan?

How Does a Nonrecourse Loan Work?

Nonrecourse loans generally work like this: an applicant applies for funding, pledges collateral, and gets approved for financing subject to nonrecourse provisions.

Nonrecourse Loan Example

A consumer, for example, can pledge a motor vehicle as collateral for a $20,000 secured personal loan that includes nonrecourse provisions in the loan agreement. The lender may seize the car if the borrower defaults on the loan, but the lender is generally restricted from taking further action.The lender could suffer a loss if the unpaid balance on the defaulted loan is greater than the value of the borrower’s collateral. In these situations, nonrecourse loans generally prohibit lenders from recovering additional compensation outside of seizing the borrower’s collateral.

When Is a Loan Issued as a Nonrecourse?

The most common type of nonrecourse loan is a mortgage loan. If a borrower defaults on their nonrecourse mortgage, the lender is able to take their house. However, if the house is worth less than the amount the borrower owes on their home, the lender is not permitted to seize any other assets or take any further action.Keep in mind that nonrecourse mortgages may only apply in 12 states: Alaska, Arizona, California, Connecticut, Idaho, Minnesota, North Carolina, North Dakota, Oregon, Texas, Utah, and Washington.

Understanding Nonrecourse Loans

Lenders may offer financing as a nonrecourse loan. What is a nonrecourse loan? As mentioned earlier, any loan agreement secured by collateral and featuring binding nonrecourse provisions is a nonrecourse loan.Nonrecourse loans can include any closed-end credit product secured by collateral. Mortgage loans, auto loans, and secured personal loans, in some cases, may fall under the nonrecourse loan definition. In general, you’re not personally liable for the debt if you default on a nonrecourse loan.

How Do You Qualify for a Nonrecourse Loan?

Here’s what a borrower may need to qualify for a nonrecourse loan:

Excellent credit
Steady income
Debt-to-income ratio below 36%
Proof of identity
Proof of income
Proof of residence

Do You Have to Repay a Nonrecourse Loan?

Borrowers are generally expected to repay a nonrecourse loan in accordance with the terms and conditions of the loan agreement. Lenders may seize the borrower’s collateral if the borrower defaults on the loan.Borrowers may also see their credit scores plunge if they default on a nonrecourse loan. Borrowers generally have to repay the loan principal and any interest charges to avoid the consequences of default.

Can a Nonrecourse Loan Become a Recourse Loan?

In some cases, a nonrecourse loan may become a recourse loan. One way this can happen is if the borrower and lender agree to a loan modification that changes the nonrecourse loan into a full recourse loan.As mentioned earlier, nonrecourse loans are collateralized financial lending products that restrict how a lender can respond if the borrower defaults on the loan. A full recourse loan, by comparison, is a financial lending product that doesn’t restrict how a lender can respond if you default on the loan. Lenders can hold you personally liable, seize any pledged collateral, and seek a deficiency judgment against you if you default on a recourse debt.As mentioned above, a loan modification may convert a nonrecourse loan into a full recourse loan. A nonrecourse loan may also become a full recourse loan if the borrower defrauds the lender with misrepresentations or fraudulent activity. Bad behavior from a borrower may empower the lender to seize the borrower’s collateral and take further legal action seeking additional compensation in the event of default.The difference between secured vs. unsecured loans is the former includes a collateral requirement, whereas the latter does not. A nonrecourse loan is a collateralized loan product, while recourse loans can either be secured with collateral or unsecured. A loan modification can convert an unsecured recourse loan to a nonrecourse loan secured by an asset if the borrower and lender consent to the change.

Is a Personal Loan a Nonrecourse Loan?

An unsecured personal loan does not meet the nonrecourse loan definition, but a secured personal loan may qualify as a nonrecourse loan. A personal loan is a nonrecourse loan if it’s secured by collateral and features at least one nonrecourse provision.A nonrecourse provision is language in a loan agreement that states or implies that the lender will not seek a deficiency judgment against the borrower in the event of default. A nonrecourse loan may permit the lender to seize a borrower’s collateral, but the financing agreement generally prohibits the lender from taking any further action to cure a default.Here are some things to keep in mind regarding personal loans:

Failing to pay and defaulting on a personal loan can have a major impact on your credit score.
Among the disadvantages and advantages of personal loans is that personal loans can help you build credit but may feature high rates of interest.
Some lenders may charge origination fees and daily simple interest on the loan.
Among the different ways to use personal loans is spending the money toward medical bills or consolidating other existing debts.
Banks, credit unions, and nonbank financial institutions can serve as lenders for a personal loan.
You can pledge your property as collateral to secure asset-based lending.
You may not have to repay a loan if you borrowed money from a loan shark.

Nonrecourse Loan Laws

Several U.S. states have laws restricting when a creditor is permitted to obtain a deficiency judgment. Banks in those nonrecourse states may foreclose on a property if the borrower defaults on a mortgage, but they may be limited from taking further action.When a default occurs on a secured loan, the outstanding loan balance may be greater than the fair market value of the borrower’s collateral. Deficiency judgments generally give lenders the ability to seize the collateral and pursue additional compensation from delinquent borrowers until recovering all losses.Nonrecourse states with major restrictions against deficiency judgments include the following:

Alaska
Arizona
California
Connecticut
Idaho
Minnesota
North Carolina
North Dakota
Oregon
Texas
Utah
Washington

Tax Implications of Nonrecourse Loans

Nonrecourse loans may have tax consequences in some cases. For example, homeowners who buy a second home with a nonrecourse loan and lose the property to foreclosure may have tax implications if they realize a capital gain or loss from the disposition. A homeowner may have to report a capital gain to the IRS if the outstanding balance on the nonrecourse loan exceeds the fair market value of the foreclosed home. A homeowner who experiences a capital loss on a foreclosed home may not be permitted to deduct the loss for tax purposes.

The Takeaway

Borrowers are required to pledge collateral for a nonrecourse loan. This means you must own a car, home, or other personal asset and present it as collateral to qualify. It also means you could lose your collateral in the event of default because it’s security for the debt.Lantern by SoFi has a user-friendly platform for comparing personal loan rates. Just provide basic information about yourself and the loan you need, and Lantern can guide you in the process to apply for a personal loan with the lender of your choice.Find and compare personal loan options with Lantern.

Frequently Asked Questions

How do I qualify for a nonrecourse loan?

Why use a nonrecourse loan?

Are you required to repay a nonrecourse loan?

Photo credit: iStock/

LCPL0923001

About the Author

Sulaiman Abdur-Rahman

Sulaiman Abdur-Rahman writes about personal loans, auto loans, student loans, and other personal finance topics for Lantern. He’s the recipient of more than 10 journalism awards and served as a New Jersey Society of Professional Journalists board member. An alumnus of the Philadelphia-based Temple University, Abdur-Rahman is a strong advocate of the First Amendment and freedom of speech.

Share this article: