Recourse Debt Meaning Example What Is Recourse Debt

Recourse Debt Meaning

Recourse Debt is one of the types of loans that are less risky for a lender for investment, as having this loan gives the lender a right to recover its investment using the collateral asset if the borrower is unable to make its promise payment or outstanding liability which is specified into a loan agreement. Also, if the current market value of the borrower’s collateral Underlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates.read moreunderlying assetsUnderlying AssetsUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates.read more is not enough to recover the outstanding loan, then as per the recourse agreement lender can claim for other assets of the borrower which were not initially used as collateral.

Recourse Debt Example

The loan agreement will specify whether the loan is recourse or non-recourse.

Mr. Brian Pinto is a United States resident and recently got a stable job in a pharmaceutical company which gets him a monthly paycheck of $8,000. Mr. Pinto plans to buy a house in New York City for $250,000. Mr. Pinto saved $50,000, So he went to a financial institution to look for options available for him to obtain the loan of the remaining amount of $200,000 for his house financing. His credit records are also not enough for this loan.

So after understating the scenario bank manager offered a recourse debt to Mr. Pinto, which specified that under the loan agreement, the financed home would be kept as collateral and taking some percentage of his paycheck directly as a monthly installment payment. Since he had no other option available to get a loan, he accepted the offer from the financial institution.

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As mentioned above, home financing is a recourse debt specified in the loan agreement.

Collections Notice: The lender might send you a notice asking for money, or the lender may sell the debt to a A collection agency refers to a firm engaged in the recovery of the default loans or dues from the borrowers on behalf of the lenders or creditors. A loan provider or creditor outsources its debt-collection function to such a third party to reduce bad debts.read morecollection agencyCollection AgencyA collection agency refers to a firm engaged in the recovery of the default loans or dues from the borrowers on behalf of the lenders or creditors. A loan provider or creditor outsources its debt-collection function to such a third party to reduce bad debts.read more that will try to collect.Take and Sell Collateral: Firstly, the financial institutionFinancial InstitutionFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more will take the collateral property, which is mentioned in the loan agreement, and sell the property to recover its outstanding loan balance.Paycheck Garnishment: If the current market value of the collateral is not sufficient to recover the outstanding loan balance, then as per the loan agreement, the financial institution may get the right to increase the percentage of the paycheck or might contact the borrower’s employer to take money out of his paycheck until all outstanding loan balance is recovered.Other Assets Attachment: In some cases, a lender might take and sell the borrower’s other assets, which are never pledged as collateral. For example, the lender may take money from the borrower’s bank account, fixed deposits, etc.

(if the debt as mentioned above is financed under Non-recourse)

Collateral assets secure Non-recourse debt. It is riskier for the lender to give non-recourse to a less creditworthy borrower, but if they do, the lender charges high interest on the loan to compensate for the risk associated with the loan. The only difference here is if Mr. Pinto defaults on the loan payment, then the lender can only claim the collateral asset pledged initially in the loan agreement, and the lender cannot seek any further compensation even if collateral assets are not sufficient to recover outstanding loan balance.

In the Non-recourse debt, the borrower sometimes defaults on the loan payment when the total outstanding loan balance is greater than the value of the assets pledged as collateral. It is also known as Strategic Default by borrowers.

Advantages of Recourse Debt

Some of the advantages of recourse debt are as follows:

Less Risky for Lenders: Recourse is backed by collateral assets and a personal asset of the borrower, so the lender has less risk than a non-recourse.Low-Cost Loan for Borrower: High creditworthy borrowers can enjoy low-interest rates on recourse compared to aA non-recourse loan is one in which the borrower must attach some form of collateral security to the loan contract, such as property, equipment, or bank fixed deposits, in order for the loan to be approved. In the event of default, the lender has the right to seize the collateral in order to clear the dues.read more non-recourse loanNon-recourse LoanA non-recourse loan is one in which the borrower must attach some form of collateral security to the loan contract, such as property, equipment, or bank fixed deposits, in order for the loan to be approved. In the event of default, the lender has the right to seize the collateral in order to clear the dues.read more.Leniency Loan in Process: Borrowers with poor credit history can also get a loan from financial institutions as under-recourse loanRecourse LoanA recourse loan is a form of loan in which the lender has the right to recover the whole amount loaned to the borrower if the borrower fails to pay. To collect the whole amount granted, the lender can seize not only the asset for which the loan was granted, but also additional assets of the borrower.read more reduces perceived risk associated with less creditworthy investors.

Disadvantages of Recourse Debt

Some of the disadvantages of recourse debt are as follows:

Borrower’s Personal Income Garnishment: Under this type of debt, if the borrower defaults on the loan, the lender can claim on the Personal income refers to the total earnings of the individuals and households of a nation through multiple sources such as salary, wages, business profits, bonus, investment returns, dividends, rental receipts, employer contribution in provident or pension funds, etc.read morepersonal incomePersonal IncomePersonal income refers to the total earnings of the individuals and households of a nation through multiple sources such as salary, wages, business profits, bonus, investment returns, dividends, rental receipts, employer contribution in provident or pension funds, etc.read more of the borrower such as wages, commission, bonuses, pension benefit, bank deposits, etc.Low-Interest Rate: The lender charges a low-interest rate for recourse debt compared to the non-recourse as this is more security to the lender if the borrower defaults on the loan payment.

Important Point to Remember

It is important to understand the terms of the loan initially.Recourse debts favor the lender.Non-recourse debt favors the borrower.For the good creditworthy borrower, recourse can benefit from enjoying a low-interest rate on loan.

Conclusion

When an individual or small business is looking for a loan, there are usually two types of loans available, i.e., Recourse and non-recourse debt. The primary difference between these two types is whether or not the borrower’s liability for the loan payment. Under the recourse agreement, the lender can go after the borrower’s assets if pledged collateral is not enough to recover the outstanding loan balance. Under the non-recourse, a lender can claim only to the collateral pledged initially if the borrower defaults on the loan payment.