Non Recourse Loan
Welcome to today’s blog! Today we will dig into the definitions and practices of using recourse and non recourse loan options. Our goal is to help you further understand what a non-recourse loan is, as opposed to a recourse loan. We also will answer a common question by new investors, “Is a commercial real estate loan a non-recourse loan?”. This article will also discuss the characteristics of non-recourse commercial real estate loans.
First, let’s dive into what non-recourse loans are. They are a type of loan in which a lender can only seize collateral — typically the property in which the loan was for and cannot go after the borrower for further requital. Recourse loans are different because the lender can seek additional compensation if the collateral doesn’t cover the full defaulted loan value, such as garnishing their wages, savings accounts, or other properties and assets. Now that we’ve covered what they are, and the difference between non-recourse and recourse commercial real estate loans, let’s jump into a common question asked by new investors.
Is a Commercial Real Estate Loan a Non Recourse Loan?
When obtaining a commercial real estate loan, it is possible to acquire either a no-recourse or recourse loan, depending on your lender and other factors influencing the deal. While it may seem obvious, as a borrower, it would be best to obtain a non-recourse loan, and as the lender, it would be best to grant a recourse loan. However, there are instances in which they are not the best loan type for borrowers, and recourse loans are not the best strategy for lenders. For this reason, let’s dive into the characteristics of no-recourse loans and related lending practices to learn more about the advantages and limitations a no-recourse loan has for both borrowers and lenders.
Typical Characteristics of a No-Recourse Loan
Stricter Underwriting Criteria
Because a no-recourse loan is riskier for lenders, they can have stricter underwriting criteria, which makes it more difficult for borrowers to get approved for commercial real estate loans.
In general, a no-recourse loan is less flexible in terms of loan structure and pricing because they are often securitized into bonds by lenders.
Longer Loan Term
No-recourse loans typically have longer loan terms than recourse loans, which is excellent if you are planning on holding the property for the length of the loan, but not ideal if you are planning on flipping the property quickly.
Not Personally Liable
Arguably the most common reason why people take out a no-recourse loan is to protect themselves against being held personally reliable if they were to ever default on their mortgage. However, it is essential to understand that there is always some level of recourse possible. Commercial real estate lenders can seize the collateral to some degree. They can do this through a “Bad Boy” carve-out. These provisions are in play when a borrower does something that is not allowed in the loan terms.
What is a Bad Boy Carve-Out?
What can make a borrower a “bad boy”? This is essentially the method investors use to protect themselves in the case where the borrower negligently or decisively conducts themselves in an unacceptable or even illegal way. There are many scenarios but false financial statements or fraudulent tax returns that represent a stronger position for the borrower or for the property are great examples. Another common example would be doing something that is not allowed within the terms of the loan, such as raising subordinate financing without primary lender approval, over-leveraging the property.
The bottom line is that all no-recourse loans carry some recourse. If a borrower is not honest or acts against the terms of the loan, they are not protected by non-recourse provisions. When this happens, they become responsible for the entire note. In the event the borrower defaults, they are responsible for all losses that the lender might incur. Some banks are even extending “bad boy” carve-outs to include sending required financial reports in a timely manner, failure to pay real estate taxes, or not failing to properly insure the property. It’s very important for borrowers to carefully read carve-out clauses. If there are these types of additions the loan may more closely resemble a full-recourse loan.
Call Abbey Mortgage to Discuss Your Recourse or No Recourse Loan Options
At Abbey Mortgage & Investments, Inc., we pride ourselves in our timely loan transactions, flexible rates, and relationships we create with our borrowers, no matter what type of loan you are seeking. As mentioned above, no-recourse loans are not always the best option for individuals looking into commercial real estate loans. Contact us today to speak with a loan specialist to discuss what kind of commercial real estate loan best suits your needs.
We look forward to helping you in your next endeavor and maximizing your investment.