Table of Contents
- Introduction to Non-Recourse Loans
- What Is Non-Recourse Finance?
- Understanding Non-Recourse Finance
- Important Note on Tax Treatment
- Where Non-Recourse Loans Are Used
- Special Considerations for Non-Recourse Loans
- Are Non-Recourse Loans Taxable?
- What Industries Use Non-Recourse Loans?
- Can a Lender Come for My Personal Assets With a Non-Recourse Loan?
- The Bottom Line
Introduction to Non-Recourse Loans
Imagine you want to develop a shopping center. You know there's the promise of rent from tenants, but while the center is still being built, there's no income generated. This is where a non-recourse loan comes in. I want you to understand that this loan product is only repaid once the project it's funding is complete.
What Is Non-Recourse Finance?
Let me explain non-recourse finance directly: it's 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. These loans are generally secured by collateral.
More broadly, a non-recourse loan is any consumer or commercial debt secured only by collateral. If you default, the lender may not seize any of your assets beyond that collateral. A mortgage loan is typically a non-recourse loan.
Key Takeaways
- Non-recourse financing entitles the lender to repayment only from the profits of the project that the loan is funding.
- No other assets of the borrower can be seized to recoup the loan upon default.
- Non-recourse financing typically requires substantial collateral and a higher interest rate and is typically used in land development projects.
Understanding Non-Recourse Finance
Non-recourse financing is a branch of commercial lending characterized by high capital expenditures, distant repayment prospects, and uncertain returns. It's 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, plus a business plan for the expanded production it will enable. Repayment happens only when the factory is up and running, and only with the profits from that production.
As the lender, they're agreeing to terms that don't include access to any of your assets beyond the agreed-upon collateral, even if you default. Payments are made only when and if the funded project generates revenue. If a project produces no revenue, the lender gets no payment. Once the collateral is seized, the bank can't pursue you for any remaining losses.
Important Note on Tax Treatment
You should know that non-recourse loans and recourse loans are subject to different tax treatments in the U.S.
Where Non-Recourse Loans Are Used
Compare a non-recourse loan with a more conventional loan, where you must begin repaying immediately in monthly installments. Not surprisingly, interest rates are generally higher on non-recourse loans to compensate for the elevated risk. Substantial collateral is also required.
These loans are often used to finance commercial real estate ventures and other projects with a long lead time to completion. In real estate, the land provides the collateral. They're also used in the financial industry, with securities as collateral.
Special Considerations for Non-Recourse Loans
Non-recourse loans are considered paid in full once the underlying asset is seized, regardless of the sale price. For recourse debt, if the institution forgives any part after seizing and selling the asset, that forgiven amount may be treated as ordinary income you must report to the IRS.
Are Non-Recourse Loans Taxable?
If you default on a non-recourse loan, the amount forgiven or canceled is not taxed.
What Industries Use Non-Recourse Loans?
Non-recourse loans are very popular in the real estate industry, plus other industries with long project timelines. Since there may not be income at the start, a non-recourse loan gives you breathing room as a project financer.
Can a Lender Come for My Personal Assets With a Non-Recourse Loan?
No. A non-recourse loan is secured only by the listed collateral. A mortgage is a good example. If you default on your mortgage, the bank can seize the house to recoup their investment, but they can't seize your car or bank accounts.
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, a non-recourse loan can save your other assets from seizure in that event.
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