Definition: Recourse debt is a loan that allows the lender to pursue the borrower’s assets in the scenario of a default. It is a debt instrument that places the borrower as personally liable to honor the financial commitment.
What Does Recourse Debt Mean?
Recourse debt instruments can also be backed by collateral but in the situation of a borrower’s default, if the liquidation value of the asset doesn’t cover the entire remaining balance of the debt, the lender can claim other assets owned by the borrower in order to fulfill the commitment. This is a less riskier loan for lenders but much more riskier to the borrower. The loan agreement will specify whether the loan is non-recourse or recourse.
Also, in some cases, a certain situation might trigger that the agreement turn from non-recourse to recourse. This is common in commercial loans, where certain clauses are established in the agreement to protect banks from sudden liquidation of the assets of the company borrowing the funds. Recourse debt instruments are also frequently taken by individuals with low credit rating, since the risk of lending money to them is high and the lender needs assurance that in the scenario of a default they can get their money back one way or the other.
Example
Mr. Lopez is a Mexican individual that was recently granted with a temporary residence in the United States. He currently has a steady job and is starting to develop his credit rating. He needs to obtain a loan to pay for his college tuition and since he doesn’t have enough credit records he went to the bank to see which options were available.
The representative offered a recourse loan that involved taking a percentage of his pay check directly. If Mr. Lopez failed his payments once the bank will go after his entire paychecks until the remaining balance of the debt is fully paid for. Since he had no other option he agreed to this set up and hopefully he will keep his job to pay for it.
