The Disadvantages of Non-Recourse Loans

Non-recourse loans are a unique type of secured loan that limit the liability of the borrower. Collateral is used to secure the loan. However, if the collateral is insufficient to cover the loan amount in the case of default, the lender simply absorbs the loss instead of going after the borrower for the remaining amount. In general, non-recourse loans are a good deal for the borrower. However, there are several disadvantages to this type of loan.

Seizure of Asset

Any secured loan comes with the risk of loss of collateral if the borrower defaults. Loan contracts always must state the terms of default, meaning they will lay out exactly when the lender has the right to seize the asset. Typically, lenders must provide several notices to the borrower when a loan has gone delinquent. If the borrower does not respond, the lender can move forward with seizing the collateral. Borrowers who receive notices of delinquency or default must act quickly to prevent the loss of an asset on a non-recourse loan, or any secured loan for that matter.

For example, if you have pledged your home as collateral for a business loan, the lender will have the right to seize your home in the case of default. Foreclosure on a home is typically a slower process than seizing other assets. Borrowers placing cars as collateral can expect a lender to move very quickly to obtain the asset in the case of default. 

Lower Loan Limits

The lender will be wary of losing money on the loan if the collateral does not hold up in value. For example, if you use a stock certificate in order to secure a non-recourse loan, the stock may go down in value over time. If you default, the lender may not make up all of the money lost by seizing and selling your stock. Because lenders are worried about this happening, they will be cautious with the limits of your loan. You may receive a lower loan-to-value ratio on a non-recourse loan than on a recourse loan.

If your asset is valued at $100,000, you may only receive an $80,000 loan. You will be placing the entire $100,000 down as collateral, however. While you maintain some power in this case, the lender will typically come out on top in the case of a default. The main exception is if the market for your collateral drops significantly in a short period of time. 

Neutral Balance Sheet Effect

Businesses will be most concerned with this final disadvantage. When you receive funding, you want that funding to appear as a positive mark on your financial balance sheet. If the loan is secured against an asset, then you lose that asset for the time being. This means you will gain nothing on your balance sheet despite the additional funds coming in. In fact, if you receive a low loan-to-value ratio on your loan, you may actually "lose money" on your balance sheet after you have obtained the financing. This is not as much of a concern for private borrowers.