Recourse loans & non-recourse loans explained

author-avatar By
on February 01, 2022 Fact Checked
Recourse loans & non-recourse loans explained

A horse is a horse of course, except when it comes to non-recourse residential home loans, which are rare in Australia for various reasons.

You’ve probably heard of ‘recourse’ and ‘non-recourse’ home loans bandied about, particularly when it comes to 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. Many home owners struggling on their mortgage found it easier to hand the keys back rather than battle to build up equity. This was a by-product of non-recourse lending. Due to home owners having negative equity, refinancing to a better deal was also out of the question.

Due to dwindling property values and non-recourse lending in a few states, lenders couldn’t recoup their losses, and dominoes started to fall. In Australia, there’s a slightly different market when it comes to non-recourse borrowing, which we’ll explain in this article.


Advertisement

Buying an investment property or looking to refinance? The table below features home loans with some of the lowest interest rates on the market for investors.

Lender

Variable
More details
  • Min 30% deposit
  • No monthly or ongoing fees, add 0.10% for offset
  • Unlimited redraws

Variable Home Loan (LVR < 70%)

  • Min 30% deposit
  • No monthly or ongoing fees, add 0.10% for offset
  • Unlimited redraws
Variable
More details
REFINANCE ONLY
  • A low-rate variable home loan from a 100% online lender. Backed by the Commonwealth Bank.
REFINANCE ONLY

Variable Rate Home Loan – Refinance Only

  • A low-rate variable home loan from a 100% online lender. Backed by the Commonwealth Bank.
Variable
More details
AN EASY DIGITAL APPLICATION
  • No ongoing fees - None!
  • Unlimited additional repayments
  • Easy online application, find out if you're approved quick!
  • Redraw- Access your additional payments if you need them
  • Use the app to get loan insights to help you pay off your home loan faster
AN EASY DIGITAL APPLICATION

Neat Variable Home Loan (Principal and Interest) (LVR < 60%)

  • No ongoing fees - None!
  • Unlimited additional repayments
  • Easy online application, find out if you're approved quick!
  • Redraw- Access your additional payments if you need them
  • Use the app to get loan insights to help you pay off your home loan faster
Variable
More details
NO ONGOING FEES
  • No ongoing fees - None!
  • Unlimited additional repayments
  • Easy online application, find out if you're approved quick!
  • Redraw- Access your additional payments if you need them
  • Use the app to get loan insights to help you pay off your home loan faster
NO ONGOING FEES

Yard PAYG Home Loan (Principal and Interest) LVR ≤ 80%

  • No ongoing fees - None!
  • Unlimited additional repayments
  • Easy online application, find out if you're approved quick!
  • Redraw- Access your additional payments if you need them
  • Use the app to get loan insights to help you pay off your home loan faster

Base criteria of: a $400,000 loan amount, variable, fixed, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. However, the ‘Compare Home Loans’ table allows for calculations to be made on variables as selected and input by the user. All products will list the LVR with the product and rate which are clearly published on the Product Provider’s web site. Monthly repayments, once the base criteria are altered by the user, will be based on the selected products’ advertised rates and determined by the loan amount, repayment type, loan term and LVR as input by the user/you. *The Comparison rate is based on a $150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate. Rates correct as of August 11, 2022. View disclaimer.

Recourse home loans explained

By default, most home lending in Australia is classified as ‘recourse’ lending. Recourse for the lender basically means if the mortgage holder defaults on their home loan, and the proceeds from the property sale do not cover the remaining debt, the lender has the right to pursue the debt through other means. 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.

Recourse Case Study

Jofre Loder has $400,000 remaining on his mortgage that he’s defaulted 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.

Under recourse lending, 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.

Non-recourse home loans explained

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, and the property is worth less than what’s owed on the mortgage, the lender can seize the dwelling but can’t pursue the additional debt through other means.

If the lender can’t recoup the remaining debt from the sale of the property, it is likely out of luck and can’t pursue the borrower’s other assets as ‘recourse’. As a consequence, non-recourse loans typically attract higher interest rates and have other restrictions to protect the lender in case of default.

Much of the literature on non-recourse lending relates to the United States, and it’s because in Australia it’s basically impossible to find a residential non-recourse home loan, as explained below.

How to find a non-recourse home loan 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.

Basically the only way you can get a LRBA is if you’re a member of a self-managed super fund or SMSF. They are more commonly called ‘SMSF loans’, but the technically-correct term is LRBA. 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.

Lender

Variable
More details
SELF MANAGED SUPER FUND LOAN
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
SELF MANAGED SUPER FUND LOAN

SMSF 80

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
Variable
More details
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

Ocean SMSF (No Offset) (Metro) (Principal and Interest) (LVR < 60%)

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
Variable
More details
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

SMSF 70 (Refinance)

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
Variable
More details
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

Liberty SuperCredit SMSF (LVR < 60%)

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
Variable
More details
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

SMSF Residential

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees
Variable
More details
  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

SMSF 70 (Purchase)

  • Easy refinance process
  • No application fee and no settlement fee
  • No monthly, annual or ongoing fees

Base criteria of: a $400,000 loan amount, variable, fixed, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. However, the ‘Compare Home Loans’ table allows for calculations to be made on variables as selected and input by the user. All products will list the LVR with the product and rate which are clearly published on the Product Provider’s web site. Monthly repayments, once the base criteria are altered by the user, will be based on the selected products’ advertised rates and determined by the loan amount, repayment type, loan term and LVR as input by the user/you. *The Comparison rate is based on a $150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate. Rates correct as of August 11, 2022. View disclaimer.

LRBAs explained

If the fund fails or the borrower can’t pay their mortgage, the lender can’t come for other assets in the fund - even if the property the loan is secured against falls in value. This is how it is ‘limited’ in recourse.

As a consequence, LRBAs generally attract much higher interest rates than on regular home loans. Only a handful of lenders offer LRBAs, too. Borrowers must also front up with a bigger deposit, with many lenders requiring at least a 20-30% deposit i.e. 70-80% LVR.

With great power comes great responsibility. If you take out an LRBA as part of your SMSF, you must also satisfy a couple of Australian Tax Office rules: the ‘at arm’s length' rule, and the ‘sole purpose’ test. Basically these two mean you can’t live in the property or lease it to a friend or family member; you must charge market rent that’s fed back into the SMSF. The sole purpose of purchasing the property must be for delivering returns for your SMSF for you and your members' retirements.

Non-recourse mythbusting

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 actually one of the many falling Jenga blocks that caused a near total collapse of the country’s financial system.

Everywhere in the United States is non-recourse - MYTH

Only 12 states have what’s generally classified as ‘non-recourse’ borrowing.

  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 only non-recourse when it comes to home equity loans - first and second home buyers are subject to recourse.

While California and Texas are the first and second most-populous states respectively, it’s not like every American has access to a non-recourse loan. Each state also has their own individual laws when it comes to recourse, especially when it comes to judicial foreclosures.

Other states such as Hawaii, Montana, Nevada, New Mexico, and Oklahoma may allow non-recourse loans with a few caveats. 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.

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.

Non-recourse loans are cheap and plentiful - MYTH

While not so much the case before the GFC, non-recourse loans typically require loan-to-value ratios of around 50-60% 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 home owner should property prices fall. This means there’s a ways to go before the mortgage is worth more than the property value i.e. negative equity.

In Australia any LRBAs, or limited recourse loans, typically restrict the borrower to 70% or at most 80% LVR. Note that here it’s limited recourse, not non-recourse.


Photo by thekurupi on Pixabay



Disclaimers

The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered. Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site. Savings.com.au, yourmortgage.com.au, yourinvestmentpropertymag.com.au, and Performance Drive are part of the Savings Media group. In the interests of full disclosure, the Savings Media Group are associated with the Firstmac Group. To read about how Savings Media Group manages potential conflicts of interest, along with how we get paid, please visit the web site links at the bottom of this page.

Latest Articles

author-avatar
Harrison is Savings.com.au's Assistant Editor. Prior to joining Savings in January 2020, he worked for some of Australia's largest comparison sites and media organisations. With a keen interest in the economy, housing policy, and personal finance, Harrison strives to deliver and edit news and guides that are engaging, thought-provoking, and simple to read.

Be Savings smart.
Subscribe for free money newsletters.

By subscribing you agree
to the Savings Privacy Policy