Recourse loans & non-recourse loans explained

You've probably heard of 'recourse' and 'non-recourse' home loans bandied about, particularly in the United States.

In the lead-up to the Global Financial Crisis of 2007-09, many properties fell sharply in value, and mortgages were worth more than the home. In certain US states, borrowers holding non-recourse loans found it easier to hand the keys back rather than battle to build up equity. Due to homeowners having negative equity, refinancing to a better deal was also out of the question.

Australia's lending landscape works differently. Here's almost all residential mortgages are recourse loans, and true non-recourse home loans are virtually non-existent.

We'll explain in this article what each loan type means and how Australia's version, the limited recourse borrowing arrangement (LRBA), works.

What is a recourse home loan?

A recourse loan gives the lender the right to pursue a defaulting borrower for any unpaid debt if the property sale doesn't cover the mortgage. Usually this means chasing the borrower's additional assets, whether that's other property, shares and so on.

Failing that, the lender might take further legal action against the borrower to recoup its losses. A court order might allow the lender to pursue the debt through other means, such as garnishing wages.

Example of a recourse loan in action

Jofre Loder has $400,000 remaining on the mortgage that he's defaulted on since he's more than 90 days past due. As he bought in Blackwater, Queensland at the height of the mining boom, the property today is only worth $350,000.

Because the loan is recourse, BBW (Big Bad Wolf) Bank pursues the additional $50,000. BBW realises Jofre has $50,000 in shares and takes legal action against him to recoup its losses through these shares.

This is the standard model for Australian home loans.

What is a non-recourse home loan?

In contrast, non-recourse loans are 'collateralised' or secured only by the asset it's held over - in most cases, a dwelling.

If a borrower defaults on their home loan:

• The lender may seize and sell the property,
• But cannot pursue the borrower for the shortfall if the property is worth less than what's owed.

As such, non-recourse loans typically attract higher interest rates and have other restrictions to protect the lender in case of default.

Why non-recourse home loans are rare in Australia

Australian lenders almost universally require recourse lending to manage risk and maintain lending stability. As a result, non-recourse residential mortgages are essentially unavailable. However, there is one exception: SMSF property loans under an LRBA.

How to access non-recourse-style lending in Australia

Here's the thing… we started out friends. No, Kelly Clarkson. Here's the thing, in Australia you can't find a totally 'non' recourse loan. Instead, you can find what's called a limited recourse borrowing arrangement, or LRBA for short.

An LRBA is commonly referred to as an SMSF property loan, and the only way you can access it is if you're a member of a self-managed super fund or SMSF. Those wishing to purchase property for SMSF purposes will only have the choice of an LRBA.

You can compare a variety of LRBAs or SMSF loans in the table below.

Loan purpose

SMSF

Loan amount

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Lender	Home Loan	Interest Rate	Comparison Rate*	Monthly Repayment	Repayment type	Rate Type	Offset	Redraw	Ongoing Fees	Upfront Fees	Max LVR	Lump Sum Repayment	Extra Repayments	Split Loan Option	Tags	Features	Link	Compare	Promoted Product	Disclosure
loans.com.au	loans.com.au SMSF Residential Refinance (Variable Inv P&I <60%)	6.89% p.a.	6.91% p.a.	$3,290	Principal & Interest	Variable			$0	$230	60%				Residential Refinance Only Investor Variable Principal & Interest 40% Min Deposit More details	Available for refinance only No application, ongoing monthly or annual fees. Dedicated loan specialist throughout the loan application	More details	Compare	Promoted	Disclosure
Firstmac	Firstmac SMSF 70 - Residential Refinance (Variable)	7.14% p.a.	7.19% p.a.	$3,374	Principal & Interest	Variable			$0	$220	70%				Residential Refinance Only Investor Variable Principal & Interest 30% Min Deposit More details		More details	Compare		Disclosure
loans.com.au	loans.com.au SMSF Residential Refinance (Variable Inv P&I <80%)	7.24% p.a.	7.26% p.a.	$3,407	Principal & Interest	Variable			$0	$230	80%				Residential Refinance Only Investor Variable Principal & Interest 20% Min Deposit More details		More details	Compare		Disclosure

How LRBAs work

If the property purchased under the LRBA cannot meet repayments or falls in value:

• The lender can repossess the property held in the LRBA trust,
• But the lender cannot access other SMSF assets, such as shares or cash reserves.

This is how it is 'limited' in recourse.

LRBA lending conditions

LRBAs generally attract much higher interest rates than regular home loans. Only a handful of lenders offer LRBAs, too.

Other things to know about LRBAs include:

• Borrowers are typically required to front up a 20-30% deposit, sometimes more, meaning 70-80% loan-to-value ratio.
• Strict compliance requirements under the Australian Taxation Office's rules must be satisfied (more on that below).

SMSF property rules to remember

An SMSF property purchased under an LRBA must meet ATO's:

• Sole purpose test - The investment must support members' retirement benefits.
• Arm's-length rule - The fund must transact on commercial terms, meaning you must charge at market rent and the income must return to the SMSF.
• Additionally, you cannot live in the property or lease it to family or related parties (unless it is business real property).

Read our explainer on SMSF borrowing to get clarity on this topic.

Mythbusting: Non-recourse loans in the United States

It's common to think people walking away from their underwater mortgages, and consequently their homes, was the root cause of the GFC in the US. The truth is, there were many causes, and this was one of the many falling Jenga blocks that led to a near-total collapse of the country's financial system.

• Myth: "Every US mortgage is non-recourse"

• Fact: Only around 12 states provide significant non-recourse protections, usually limited to money mortgages or non-judicial foreclosures.

These states include:

1. Alaska
2. Arizona
3. California
4. Connecticut
5. Idaho
6. Minnesota
7. North Carolina
8. North Dakota
9. Oregon
10. Texas*
11. Utah
12. Washington

*Texas is non-recourse for home equity loans only. Standard purchase mortgages remain recourse.

Other states may offer partial protection depending on the foreclosure type or loan structure. Nevada's recourse law, in particular, is interesting because single-family mortgages written after 2009 are not subject to recourse if the financial institution has not allowed refinancing.

1. Did you know: A 2011 research paper from the Federal Reserve Bank of Richmond found borrowers in recourse states of the US were 32% more likely to default than borrowers in non-recourse states. For mortgages over $500,000, that figure jumped to more than double.

• Myth: "Non-recourse loans caused the GFC"

• Fact: They contributed to strategic defaults but were not the root cause. Subprime lending, securitisation failures, and poor underwriting standards were far larger drivers.

• Myth: "Non-recourse loans are cheap and easy to get"

• Fact: They typically require around 50-60% LVR in the United States. This means a borrower needs a 40-50% deposit. They may also attract a much higher interest rate than recourse loans. A lower LVR provides a bigger 'buffer' for the homeowner should property prices fall. This means there's a way to go before the mortgage is worth more than the property value, i.e. negative equity.