Non-Recourse Sale

What Is a Non-Recourse Sale?

Non-recourse sale refers to the sale of an asset in which the buyer assumes the risk of an asset being defective. It often refers to the sale of unpaid debt by a lender to a third party who can then attempt to profit by successfully collecting the remaining debt.

Understanding Non-Recourse Sales

A non-recourse sale is a transaction between a buyer and a seller where the buyer accepts liability resulting from a defect in the asset sold. The term is generally used to describe the terms of a loan agreement, but it can also refer to a lender's sale of bad debt to a third party, such as a debt collector.

The third party purchases the debt at a significant discount to the face value of the debt, and it is able to profit from the transaction if it can successfully collect on the debt. If unsuccessful, the third party cannot attempt to collect from the selling lender. According to the IRS, the tax impact of debt depends on whether it was recourse or non-recourse. The borrower is not personally liable for any non-recourse debt.

Non-Recourse Real Estate Sales

In real estate, recourse refers to the ability of a lender to seek repayment from a borrower after foreclosure. When a borrower fails to keep up with mortgage payments, the lender has the right to initiate foreclosure by taking control of the property. Often, the lender will then sell the property to recover the loan, but that sale may not fully cover the outstanding debt.

The difference between the proceeds of a foreclosure sale and the outstanding debt is known as a deficiency balance. If the loan was closed in a non-recourse state, the lender is not able to pursue the deficiency from the borrower. In a recourse state, the lender could seek final repayment through the seizure of property or cash assets from the borrower. This distinction places additional risk on a lender in a non-recourse transaction.

Recourse laws vary from state to state, particularly with regard to the extent to which the holder of debt can pursue recovery from the borrower. One-action recourse states, such as California, allow the debtholder to make one attempt, generally a foreclosure or lawsuit. Other states, such as Florida, have enacted statutes of limitations on collection efforts.

These rules are designed to protect the borrower from harassment or aggressive collection actions. In some non-recourse states, only purchase-money loans are protected. Refinanced mortgages, or home equity lines of credit (HELOCs), may be subject to recourse.

Non-recourse loans are more attractive to borrowers, but they tend to have higher interest rates to compensate for the risk assumed by the lender.

Example of a Non-Recourse Sale

Priya buys a home for $200,000 in a nice neighborhood and takes out a non-recourse loan for $160,000 from her local bank. But she loses her job after three years and is unable to keep up with mortgage payments. She defaults on the loan soon after.

In the meantime, real estate prices for the neighborhood have crashed and her home is now worth only $150,000. Priya's bank forecloses the home, sells it for $150,000, and is forced to absorb the $10,000 loss.