What is Nonrecourse Debt?

Nonrecourse debt is a secured debt or loan that entitles a lender to take control of collateral in the event that a debtor fails to make payments on the outstanding balance. In general, the terms and conditions of this type of secured loan prohibit the lender from attempting to gain control of assets that were not pledged as collateral. The nonrecourse loan is one of the most prevalent types of consumer loans offered by banks and other financial institutions today.

Sometimes identified as non-recourse debt, this structure does provide some degree of protection for both parties. The lender is assured of at least partially recouping the investment made in the defaulted loan, based on the current value of the collateral pledged when the loan was granted. At the same time, a debtor who is suddenly unable to make payments on the outstanding balance does not have to be concerned about a wide range of assets being seized in order to settle the debt; all he or she stands to lose is whatever collateral was pledged.

Because of the structure of nonrecourse debt, lenders normally apply rigid standards to the type of property or assets that can be pledged as collateral. Generally, the property is expected to not depreciate in value at a rate faster than the scheduled repayment of the outstanding balance. Many lenders will also only lend up to 90% of the actual value of the property, further protecting their interests in the event of a default. This process is logical, as the lender typically assumes more risk than the borrower when making a loan.

In real estate deals, nonrecourse debt is a common approach when financing commercial development projects, given the long term investment that is usually required. This type of debt structure is also used with loans to finance stock deals and other investment strategies. The expectation is the same as with any type of loan; that is, the debtor is anticipated to pay off the balance due on time and according to the terms and conditions specified in the loan agreement.

Obtaining a nonrecourse loan is possible with just about any bank or credit union with enough assets on hand to process the loan amount. Generally, the debtor must meet the criteria set in place by the lending institution, even when the collateral is of sufficient value to cover the amount of the loan. As with any type of financial obligation, failure to repay according to terms can result in damage to the credit rating, even after the outstanding nonrecourse debt is settled by the lender assumes control of the collateral.