Definition and Examples of Limited Recourse Debt
Limited recourse debt is a type of debt where collateral secures the loan. This collateral is outlined in the loan agreement and the lender can only take that collateral in the case of nonpayment. It can’t seize any other assets that belong to the borrower, even if the collateral doesn’t cover the debt.
For example, a lender might make a limited recourse loan to a business to finance a specific project. The loan agreement could specify that if the debt isn't paid, the lender is entitled to seize revenue and proceeds from that one project only. The lender would be able to take money earned through the financed project but not revenue earned from other business operations.
Limited recourse debt is just one category of debt:
- Full-recourse debt: Lenders can take many different assets to collect on unpaid debt, such as any collateral guaranteeing the loan, including a car for a car loan or a home for a mortgage. If there's still an outstanding balance due, lenders could pursue further claims against the borrower. They could potentially garnish wages or levy other accounts.
- Nonrecourse debt: Allows lenders to take only collateral that directly guarantees the loan in case of nonpayment. Lenders cannot pursue any other legal claims if the seizure of the collateral isn't sufficient to satisfy the unpaid debt in full.
- Limited recourse debt: Lenders have the chance to seize any collateral that is specified in the loan agreement—but no other borrower assets.
How Limited Recourse Debt Works
With limited recourse debt, the borrower and lender agree that certain assets will serve as collateral. Those assets will guarantee the loan. They will be listed in the loan agreement, which also specifies that the debt is limited recourse debt.
If the borrower does not pay back the loan, the lender can take the assets mentioned in the loan agreement, but it cannot take any other assets that belong to the borrower. This is true even if the collateral isn't enough to fully satisfy the outstanding balance.
If the lender isn't fully repaid after seizing the collateral, the lender cannot garnish the borrower's wages or aim to put a levy on the borrower's bank account. All of the borrower's other assets are safe.
Limited recourse debt is a hybrid between secured and unsecured loans. Secured loans ensure there is sufficient collateral to guarantee the loan will be repaid in full. Unsecured loans have no collateral. Limited recourse debt has some collateral but it may not always be sufficient to cover the payment owed to the lender.
Alternatives to Limited Recourse Debt
Full recourse debt and nonrecourse debt are both alternatives to limited recourse debt.
Full Recourse Debt
Full recourse debt provides more protection to lenders because the lender is allowed to seixe other collateral not outlined in the loan agreement to collect on the debt. If the borrower doesn't pay, the lender can take any collateral.
If there's still an outstanding balance, the lender could go to court and get an order for wage garnishment. The lender could also go to court and have a lien put on the borrower's home or bank account. All of the borrower's assets are theoretically at risk.
Auto loans are a common example of recourse debt because a lender could seize the vehicle and, if the borrower still owes an amount such as $1,000, the lender could pursue other steps to recover that remaining $1,000 balance.
Nonrecourse debt doesn't give the lender the opportunity to pursue any claims against the borrower other than for the collateral. The lender takes on more of the risk with this type of loan.
One example of this is a home loan in states that don't allow deficiency judgments. In these cases, the lender could foreclose on the home for nonpayment. But after the home is sold, the lender cannot try to collect any more money, even if there's still an outstanding mortgage balance.
- Limited recourse debt is secured by collateral specified in the loan agreement.
- Lenders can take the specified collateral in case of nonpayment, but they cannot take other borrower assets for nonpayment beyond that specified collateral.
- Alternatives to limited recourse debt are full recourse debt and nonrecourse debt.
- Your loan agreement should specify the type of debt.