by Trevor T. Calton
There are two different kinds of loans: recourse and non-recourse. Recourse debt is when the borrower is personally liable for the entire debt amount, regardless of the collateral or the security that's being offered on the loan. Non-recourse debt means that the borrower is not personally liable and the lender's only security is the collateral itself.
But for most loans, recourse or non-recourse doesn't matter. The only time the difference between the two comes into play is in the event of foreclosure. When a lender forecloses, they take the property back and sell it to recoup the money they loaned to the borrower.
If the property's worth $1,000,000 dollars when they sell it, and they loaned $800,000, then they have enough to cover the money that they loaned out plus other expenses and costs. But sometimes the property does not hold its value. It goes down in value. And this can happen because of mismanagement of the property or the borrower not having enough funds to properly maintain it.
There are a lot of different reasons why a property could lose value. But let's say in this example that a property was worth a million dollars, and the lender loaned 800,000 on it, but over time, for whatever reason, the property became worth 600,000. This difference here between what the property is worth and what the lender is owed is called a deficiency.
Important to note is that the deficiency isn't just the difference between the loan amount and the property's new value the lender has. In addition to the principle they're trying to recover, they have, they are also owed accrued interest, legal fees, late fees, and other expenses related to the foreclosure process.
So in an example like this, that deficiency could very easily be $300,000 or $400,000, instead of just $200,000.
In a case of a recourse loan, the lender is able to sue the borrower for recovery of the deficiency amount. They can go after other assets or other find other ways to get a judgment in court to recover whatever the collateral did not cover.
In a non-recourse loan, the lender is not able to go back to the borrower and sue them for the deficiency. The lender has no recourse against the borrower.
So which is the better option for you? Typically, if your project is stabilized, has plenty of value relative to the loan amount, and has a low risk of failure, then a recourse loan will probably be fine. And the interest rate will typically be lower, as well. If your project has a higher risk profile and you are concerned about a potential deficiency, then try to find a non-recourse loan.
If you’re not sure, or you want to explore your options, give us a call at Evergreen Capital and we are happy to advise you about your options at 877.325.4001 or firstname.lastname@example.org
Trevor T. Calton, MBA is the President of Evergreen Capital Advisors and founder of Real Estate Finance Academy. A longtime industry veteran and former Professor of Real Estate Finance, he has analyzed, acquired, or sold more than $5 billion of commercial real estate assets, financed over 500 commercial investment properties, and overseen the asset management of over 6000 units of multifamily housing.