Non-Recourse Finance: Definition, Uses, Vs. Recourse Loan

What Is Non-Recourse Finance?

Non-recourse finance is a type of commercial lending that entitles the lender to repayment only from the profits of the project the loan is funding and not from any other assets of the borrower. Such loans are generally secured by collateral.

A non-recourse loan, more broadly, is any consumer or commercial debt that is secured only by collateral. In case of default, the lender may not seize any assets of the borrower beyond the collateral. A mortgage loan is typically a non-recourse loan.

Understanding Non-Recourse Finance

Non-recourse financing is a branch of commercial lending that is characterized by high capital expenditures, distant repayment prospects, and uncertain returns.

In fact, it is similar in character and risks to venture capital financing. For example, say a company wants to build a new factory. The borrower presents a bank with a detailed plan for the construction, in addition to a business plan for the greatly-expanded production that it will enable the company to undertake. Repayment can be made only when the factory is up and running, and only with the profits of that production.

The lender is agreeing to terms that do not include access to any of the borrowers' assets beyond the agreed upon collateral, even if they default on the loans. Payments will only be made when and if the funded projects generate revenue. If a project produces no revenue, the lender receives no payment on the debt. Once the collateral is seized, the bank cannot go after the borrowers in hopes of recouping any remaining losses.

Where Non-Recourse Loans Are Used

Compare a non-recourse loan with the more conventional loan, in which the borrower must begin repaying immediately and in installments every month thereafter. Not surprisingly, interest rates are generally higher on non-recourse loans to compensate for the elevated risk. Substantial collateral is also required.

Non-recourse loans are often used to finance commercial real estate ventures and other projects that involve a long lead time to completion. In the case of real estate, the land provides the collateral for the loan. They also are used in the financial industry, with securities used as collateral.

Special Considerations for Non-Recourse Loans

Non-recourse loans and recourse loans are subject to different tax treatments in the U.S. Non-recourse loans are considered to be paid in full once the underlying asset is seized, regardless of the price at which the asset is sold.

In the case of recourse debt, if the financial institution forgives any part of the debt after the associated asset is seized and sold, the forgiven amount may be treated as ordinary income that the debtor must report to the Internal Revenue Service.

The Bottom Line

Non-recourse loans offer several benefits to businesses planning large projects, including different tax considerations, and the ability to avoid payment until the project comes to fruition. While it's never ideal to default on a loan, a non-recourse loan can save your other assets from seizure in the event of default.