Should you opt for a recourse loan, or would a non-recourse loan be the best bet for your real estate investment?
Before you consult your lending firm representatives and sign up for either one of these loans, know the difference between a recourse loan and a non-recourse loan.
This blog breaks down non-recourse loans, how they work, and if they’re the right financing option for your commercial real estate venture. Take a look!
Non-Recourse Loan: What is it?
Just like a recourse loan or a hard money loan, non-recourse loans are also backed with assets or collateral. If the borrower fails to repay the loan amount on time, the lender or the lending firm has the right to seize the property and recoup their losses from the collateral’s resale.
However, it’s important to note that non-course loans permit the lender to seize just the collateral and not any other asset.
What does this mean?
If a borrower cannot close the loan or defaults, the lending firm will get the right to bank the collateral’s value and resell it. However, if there’s a market crash and the collateral sells for less than its anticipated value, the lender does not have the right to seize other assets to recover their losses.
Non-Recourse Loan: How does it work?
Consider you’re a homebuyer who has set their heart on a property valued at $400,000. After you’ve put a down payment of $50,000, you need a lender to lend you $350,000.
Unfortunately, you weren’t able to repay your loan on time and defaulted at $275,000. The lender will have to foreclose the collateral and put it up for sale to retrieve the outstanding debt amount.
However, the real estate market is witnessing a downward trend, and the collateral doesn’t bring in more than $250,000 in sale value. In a non-recourse loan, the lender or the bank will bear the costs of the outstanding debt of $25,000, and doesn’t have the right to foreclose the borrower’s other assets.
What Sets it Apart From a Recourse Loan?
If both recourse and non-recourse loans are backed by collateral, where does the difference lie?
With a recourse loan, the bank, credit union, or the private lender can all resort to the borrower’s other assets. This means that they can go after any other property, cars, or valuables that the borrowers might have on their name, seize them, and sell them to recover their losses.
Recourse loans are more preferred by private lending firms and banks as they protect the lenders. Moreover, recourse loans are designed to reduce risks for the lender, which is why they come with lower interest rates for the borrower.
On the other, non-recourse loans are designed to favor the borrower. This is why they come bearing high risks, and ultimately, high-interest rates. If a borrower can’t repay their loan amount and their interest, the lender has no other option but to make do with the collateral and pay for additional debts on their own.
Who Should Apply For a Non-Recourse Loan?
Since non-recourse loans come with favorable terms for the borrowers, they are often used in commercial real estate transactions. The land or the undeveloped property acts as collateral, and its anticipated resale value can get borrowers approved for the non-recourse loan.
Moreover, commercial properties often come with high resale values. This can help reduce the risk for the investors and incline them to extend non-recourse loans to successful property flippers and real estate developers.
How To Qualify For a Non-Recourse Loan?
Since non-recourse loans put the lenders at high risk, they’re offered by just a handful of banks, credit unions, and private lenders. If you live in one of the 12 non-recourse states or have found a lender who’s willing to extend a non-recourse loan, here’s how you can get it approved.
Low Debt-To-Income Ratio
A high debt-to-income ratio might put off the underwriters from approving your non-recourse loan.
To ensure that you qualify for the non-recourse loan, try to maintain a low and steady DTI. This leads to a financial picture that you’re apt at managing and paying off your debts with your fixed income source.
To improve your chances of getting approved for a non-recourse loan, try to lower your DTI by paying off outstanding debts and increasing your sources of income.
Have a High-Value Collateral
Collaterals are presented to lower risk for the lender and improve loan terms for borrowers.
With high-value collateral, the lender might be more inclined to extend a non-recourse loan, lower interest rates for the borrowers, and give them more leeway for the loan amount.
Good Credit Score Counts
Your credit score depicts your creditworthiness; the higher it is, the better your loan landing prospects.
Lenders are always inclined to extend loans to borrowers that have high credit scores, unblemished financial histories, and credit reports. To get approved for a non-recourse loan, pay your debts on time, avoid maxing out on your credit limit, and dispute any errors on your credit report.
Pay High-Interest Rates
If you’re willing to pay high-interest rates for the entire loan duration, then lenders might just approve you for a non-recourse loan.
These high-interest rates help the lenders lower their risks. However, if you pair these already high interest rates with a low down payment, shorter loan duration, and a consistently poor credit score, expect to pay exorbitantly high-interest rates!
Work with a leading private money lending firm in the United States.
A private lending firm such as Commercial Private Equity can help you secure a hard money loan for your real estate transaction.
Our representatives will guide you through the loan application process, our company policies, and our requirements to get approval.
Moreover, our private lending firm offers low-interest rates and low LTV ratio loans, and customizable financing solutions for our clients.