Recourse vs. Non-Recourse Commercial Real Estate Loans
Following is an overview of the differences between recourse and non-recourse loans.
Recourse and Non-Recourse Financing Options
The main distinction between a recourse and non-recourse loan is whether the borrower or guarantors have personal liability for an outstanding balance. Recourse loans allow lenders to collect what is owed after they have taken collateral, while non-recourse loans limit lenders to repayment through collateral. If there is a shortfall between the sale price of a property and what is owed to a lender, a recourse loan permits the lender to pursue the guarantors personally to cover the difference, which may involve seizing wages, bank accounts, or other assets to satisfy outstanding debt.
While non-recourse financing generally means that the borrowers are not personally liable, there are exemptions. These “bad boy” carve outs permit lenders to convert a non-recourse loan to a recourse loan due to events such as bankruptcy, failure to pay property taxes, fraud, and criminal activity, among others. The specific exemptions vary by lender, and they will be outlined in loan documents.
Advantages of Each Loan Type
While it may seem like a non-recourse loan is the best option as it provides significant protection by limiting personal liability, there are advantages to recourse loans. Non-recourse loans may be associated with cash flow restrictions and a maintenance schedule through which lenders protect their collateral, whereas recourse loans generally have fewer restrictions. There also is less flexibility with non-recourse loans, which can make them less attractive to investors seeking greater customization of how their loan is priced and structured. If investors plan to keep a property for the length of the loan or do not anticipate seeking loan modifications, a non-recourse loan may suit their needs. On the contrary, if investors are seeking greater customization, a recourse loan may be a good option.
Legal Interpretation Varies by State
As each lender may have its own set of expectations, each state may vary in its legal interpretation. It is important to review loan documents with trusted advisors including lawyers who specialize in commercial real estate and accountants who can discuss the financial impact of various scenarios. This will help to guide you toward the loan that best suits your comfort level and investment objectives.
While multiple factors affect whether a particular property will be a good investment, the type of financing that you secure is a major consideration. Your mortgage broker can help you to navigate the complexities of the commercial real estate lending marketplace and identify the best loan structure for your needs, taking into account the terms and rates that are available to you. Being informed about the differences between recourse and non-recourse loans can be helpful during these discussions.