Nonrecourse debt is debt that is secured by collateral but for which the borrower isn't personally liable. Hence, if the borrower were to default on the loan, the lender could only recover against the collateral, not against the borrower personally.
Below are some additional points to understand about nonrecourse debt:
- Limited Liability: The primary feature of nonrecourse debt is that the borrower's liability is limited to the collateral. If the value of the collateral falls below the outstanding loan amount and the borrower defaults, the lender has to absorb the loss.
- No Personal Guarantee: Unlike recourse loans, nonrecourse loans do not require a personal guarantee from the borrower. This means that the lender cannot go after the personal assets of the borrower in case of default.
- Higher Interest Rates: Due to the increased risk for lenders, nonrecourse loans often come with higher interest rates compared to recourse loans.
- Protection for Borrowers: Nonrecourse loans provide a level of protection for borrowers, especially in volatile markets. If the value of the collateral drops significantly, borrowers can walk away from the loan without facing further financial consequences beyond the loss of the collateral.
- Risk for Lenders: Lenders take on more risk with nonrecourse loans. They rely heavily on the value and marketability of the collateral. As a result, lenders typically conduct thorough due diligence on the collateral and may have stricter loan-to-value ratios.