What Is Recourse?

Recourse allows a lender to claim additional money from a borrower in default, beyond the pledged collateral.

Recourse refers to the legal right of a lender to claim compensation from a borrower who defaults on a loan, beyond seizing the property pledged as collateral. This means that if the value of the collateral does not cover the outstanding loan amount, the lender can pursue additional assets or income of the borrower to satisfy the debt.

Types of Recourse

Full Recourse

In full recourse lending, the borrower is fully liable for the debt. The lender can claim the pledged collateral and pursue the borrower’s personal assets if the collateral does not cover the loan amount.

Limited Recourse

In limited recourse lending, the lender’s ability to claim additional assets from the borrower is restricted to specific conditions or amounts outlined in the loan agreement.

Recourse vs. Nonrecourse Debt

While recourse debt allows lenders to pursue additional assets, nonrecourse debt limits their claims strictly to the collateral. In nonrecourse loans, if the collateral’s value is insufficient to cover the debt, the lender must absorb the loss.

Examples of Recourse in Practice

Residential Mortgages

In recourse states, if a borrower defaults on their mortgage, lenders can seize the home and, if it sells for less than the owed amount, can sue the borrower for the deficiency.

Business Loans

For business loans secured by equipment or real estate, a recourse clause means the lender can claim other business assets or even personal assets of the business owner to recover the debt.

Historical Context

Recourse lending has been a common practice since the early days of modern banking. It enhances lenders’ security, reducing their risk by expanding potential sources of debt recovery.

Applicability in Different Jurisdictions

Recourse laws vary by country and even within regions of countries. For example, some U.S. states like California are considered nonrecourse states for residential mortgages, while others like Florida allow for recourse lending.

Comparisons with Related Terms

Nonrecourse Debt

A loan where the lender cannot claim anything beyond the collateral.

Secured Debt

Any loan backed by collateral, be it recourse or nonrecourse.

Unsecured Debt

Loans not backed by collateral, where lenders rely on the borrower’s creditworthiness.

FAQs

What is the main advantage of recourse loans for lenders?

The primary benefit is reduced risk, as lenders can pursue borrowers’ other assets if collateral is insufficient.

How does recourse affect borrowers?

It increases risk for borrowers, as their assets beyond the collateral can be targeted in case of default.

Are there any protections for borrowers in recourse agreements?

Typically, borrowers negotiate terms to limit recourse or include conditions to soften the impact.

References

1. Investopedia. “Recourse vs. Nonrecourse Loan.” Link.
2. Financial Dictionary. “Recourse Definition” Link.

Summary

Recourse lending provides security to lenders by granting the right to claim borrower assets beyond the pledged collateral in case of loan default. It stands in contrast to nonrecourse lending, where recovery is limited to the collateral. This practice impacts both lenders and borrowers, shaping the risk and security dynamics in financial agreements. Understanding the nuances of recourse can inform better financial decisions and negotiations.