Non-Recourse Loan Default: 3 Consequences

A non recourse loan is one where the lender can only attach the collateral that was pledged to the loan. This limit protects the interest of the borrower against the interests of the lender.  Many states require non recourse loans for borrowers over recourse loans. Recourse loans provide a way for a lender to attach additional assets of the borrower.

The consequences of defaulting on a non recourse loan includes the loss of the collateral asset pledged for the loan, a reduction in the borrower’s credit score and a possible capital gain if the amount of the loan is less than the sales proceeds received from selling the property.

Loss of Collateral Due to Default

The collateral pledged for the loan is subject to seizure upon loan default. This is part of the contract’s term and cannot be changed. This means that if an asset such as a home or a car is pledged as collateral, this asset will be surrendered in order for the loan to be satisfied. Losing a home or car due to a loan default can be a devastating consequence of a non recourse loan.

Reduction of Credit Score

The effects of a non recourse loan default, as with any other loan is a reduction in the borrower’s credit score. This reduction is a direct result in the borrower’s inability to make payments on a timely basis in order to maintain their credit score. The reduction in a borrower’s credit score will result in further difficulty applying for loans and borrowing money.

Maintaining a good credit score not only affects a persons ability to borrow money but may also affect their employment opportunities, security clearance for certain government jobs and the type of places they can live.

Possible Capital Gains

If the amount a lender receives from selling the collateralized asset, such as a home, exceeds the amount of the loan a capital gain results for the borrower. If the amount in capital gains exceeds $250,000 for an individual or $500,000 for a couple this results in a maximum 35 percent short-term or 15 percent long-term capital gains tax, based on income.

The capital gains tax is due regardless of whether the borrower receives the sale proceeds or not, which they will not. The resulting gain received from the sale means that the borrower is deemed to have benefited from the appreciation in value from the sale of the home even though the gain was not realized by the borrower.