A non-recourse loan is a great choice for borrowers who are looking to purchase a vehicle or other expensive purchase. This type of personal loan that is secured by collateral. Because lenders aren’t able to pursue a borrower for further payments after they seize the collateral, they’re often an attractive option for potential borrowers. However, since non-recourse loans are seen as a riskier investment for lenders, they often come with higher rates and fees.
What is a non-recourse loan?
A non-recourse loan is a personal loan that is secured by collateral. Collateral can take the form of a car, home or other valuable possession. If you fail to pay back a loan, a lender can seize the collateral. However, lenders aren’t able to pursue a borrower for further payments after they seize the collateral. For example, if you purchase a vehicle, you may take out a non-recourse auto loan for the car’s price, minus any down payment. If you default on your auto loan, your lender has the right to seize the collateral for the loan, which in this case means your car. However, your car’s value has likely dropped since you purchased it, meaning that the lender has essentially lost money even if they repossess your car. Once they have seized the collateral, lenders aren’t allowed to collect any further payments from borrowers, even if they’ve lost money on the loan.
The discrepancy in value between the total debt owed and the value of the collateral is known as a deficiency balance. If the borrower has taken on recourse debt, the lender’s authorized to pursue borrowers for the deficiency balance — even after the lender has seized and liquidated the collateral. However, if the borrower has taken out a non-recourse loan, the lender cannot collect the deficiency balance after seizing and liquidating the collateral.
Everything you need to know about non-recourse loans
In general, lenders prefer recourse loans over non-recourse loans, since they’re often able to recoup the full loan even if borrowers default on a recourse loan, while they may take a loss on a non-recourse loan if a borrower defaults. Because of this, non-recourse loans often come with higher rates and fees to protect lenders against risk. It also may be more difficult for borrowers with poor credit to qualify for a non-recourse loan, as they may be perceived as more likely to default. If you default on non-recourse debt, it does negatively affect your credit, which can make it harder to qualify for other loans in the future.
How to apply for a non-recourse loan
The application process for a non-recourse loan is similar to that of a regular loan application. In many cases, a specific piece of property may be involved, such as a car or real estate purchase. Before purchasing the property, borrowers will have to secure a loan from a bank or other lender. When applying for a non-recourse loan, you should:
- Make sure you have good credit — lenders are less likely to issue non-recourse loans to borrowers with poor credit. A score above 670 will help you qualify.
- See if you can get preapproved for a loan without affecting your credit score.
- Gather any important documents, including information about the property you’re purchasing.
- Compare different lenders to find the most favorable rates and see if you prequalify.
- Complete an application online or in person.
Tax implication of a non-recourse loan
It’s important to consider the non-recourse loan tax consequences. When a recourse loan is canceled or forgiven, you may be on the hook to pay taxes on the forgiven amount. However, when a non-recourse loan is forgiven (or you default), you aren’t responsible for any additional tax burden.
Pros and cons of non-recourse loans
Pros of non-recourse loans for borrowers
- If you default on the loan, lenders aren’t able to pursue you for anything other than the collateral.
- You won’t be subject to additional taxes if you default on your loan or have your loan forgiven.
- Borrowers do not have personal liability for non-recourse loans.
Cons of non-recourse loans for borrowers
- Non-recourse loans often come with higher fees and interest rates, since they pose a greater potential risk to lenders.
- If you default on a non-recourse loan, you risk losing valuable personal property such as a car or home.
- Borrowers with poor credit may not qualify.
- While lenders aren’t able to pursue you for additional payments after seizing your collateral, defaulting on a non-recourse loan can still have a significant negative impact on your credit score.
Alternative financing options
If you’re considering a non-recourse loan, there are other options available to you as well. If you have poor credit or short credit history, for example, you may not qualify for a non-recourse loan, but may still be able to secure the necessary funds through an alternative financing option. These include:
- Paying for a purchase in cash: This can be a great option for borrowers who have a significant amount of money put away since you’ll save on interest and fees in the long term.
- Borrowing money from friends or family members: If you have relatives or close friends willing to lend a hand, you may want to consider borrowing money from them, especially if you have poor credit. If you borrow money from a friend or loved one, be sure to make the repayment terms clear, be responsible and pay them back as soon as possible.
- Using a credit card: While credit cards tend to have higher interest rates than loans, they can be easier to qualify for. If you weren’t approved for any other loan options, credit cards are a viable alternative.
- Taking out a personal loan: Personal loans are another option when it comes to financing. These loans are typically unsecured, so lenders can pursue you for the full amount owed but can’t seize any collateral.
- Taking out a full recourse secured loan: In recourse secured loans, a lender may seize the collateral and also pursue borrowers for additional payments. This loan option may enable you to secure lower rates than a non-recourse loan.
Too long, didn’t read?
Non-recourse loans are, in general, a good option for borrowers who can qualify for them. Even if a borrower defaults on a non-recourse loan, lenders aren’t able to pursue borrowers for additional payments after they seize the loan collateral. This means that, in the case of default, borrowers often come out at a loss. Because of this, however, lenders often charge higher rates and fees to compensate for the increased risk.
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