Overview

Nonrecourse and recourse loans are the two principal liability frameworks lenders use for secured real estate debt. The practical difference is how far a lender can go to recover its loss if you default: is recovery limited to the property only (nonrecourse), or can the lender pursue you personally for any remaining shortfall (recourse)? This matters for investors, small business owners, and homeowners who want to manage personal risk and tax exposure.

How the two work (short comparison)

  • Liability: With a nonrecourse loan, the lender’s remedy is generally limited to repossessing the collateral. With a recourse loan, the lender may seek a deficiency judgment and collect against personal assets.
  • Typical uses: Nonrecourse financing is common in commercial and some institutional real estate deals; recourse loans are the norm for most residential mortgages and small-business real estate loans.
  • Pricing and underwriting: Lenders price nonrecourse loans higher and apply stricter underwriting (lower loan-to-value, stronger cash flow) because they carry more lender risk.

Key legal details borrowers must watch

  • Deficiency judgments: After foreclosure or short sale, a lender pursuing a deficiency judgment can ask a court to order you to pay the difference on a recourse loan. In most nonrecourse loans the lender cannot seek a deficiency—except where specific carve-outs apply.
  • Bad‑boy carve-outs and recourse exceptions: Commercial nonrecourse loans commonly include “bad‑boy” or limited recourse carve-outs. These convert part or all of a nonrecourse loan into recourse if the borrower commits fraud, intentionally damages the property, transfers the asset improperly, or files a bad‑faith bankruptcy. Read loan documents carefully and ask for explicit language on carve-outs (Investopedia overview).

Practical examples

  • Nonrecourse example: A commercial investor defaults on a nonrecourse loan for an office building. The lender forecloses and sells the building; it cannot pursue the investor for the remaining balance unless a carve-out applies.
  • Recourse example: A homeowner defaults and the lender forecloses and sells for less than the loan balance. On a recourse mortgage, the lender may sue for the deficiency and collect from other assets.

Tax and foreclosure considerations

The tax treatment differs and can be material. Generally: when a lender cancels or forgives debt, the borrower may face cancellation-of-debt (COD) income under IRS rules; however, with nonrecourse loans, a foreclosure typically is treated as a sale of the property rather than discharged debt. For recourse loans, a deficiency that is later forgiven may be reported as taxable income. Because tax outcomes depend on facts and current law, consult a tax professional or the IRS guidance on debt forgiveness (see IRS resources).

(In my practice) I routinely advise clients to review both loan covenants and tax implications before signing. A nonrecourse label alone is not enough—read for carve-outs, guaranty clauses, and enforcement rights.

How borrowers can pursue nonrecourse protection or better terms

  1. Target lenders that specialize in commercial or agency-backed loans that offer limited recourse. These lenders are accustomed to structuring true nonrecourse financing.
  2. Improve your deal profile: lower loan-to-value (LTV), good property cash flow, and strong sponsor equity reduce lender risk and improve pricing.
  3. Negotiate carve‑out language: ask to narrow or remove bad‑boy carve-outs when possible, or limit guaranties to specific situations and amounts.
  4. Consider entity structure: holding property in a properly maintained LLC can add operational liability separation—but it won’t convert a recourse loan into nonrecourse; lenders may still require personal guaranties.

Common borrower mistakes

  • Assuming any loan that is “nonrecourse” gives full personal immunity—always check for carve-outs and guaranties.
  • Ignoring tax consequences of foreclosure or debt forgiveness. Get tax advice early.
  • Focusing only on interest rate and monthly payment instead of long‑term liability and enforcement terms.

Where to learn more (internal links)

Authoritative sources and further reading

Professional disclaimer

This article is educational and does not constitute legal, tax, or investment advice. Loan language and tax rules change; consult an attorney, tax advisor, or your lender for guidance tailored to your situation.