Recourse vs. Non-Recourse Mortgages
What’s the difference between a Recourse and Non-Recourse mortgage? Let’s first understand the terminology. Recourse is a legal term inferring the right to collect. In simple terms, a Recourse Mortgage means the Borrower is responsible for repaying the loan. The lender can therefore look beyond the value of the real estate pledged as collateral. Collection of the debt can be made from the Borrower, should the value of the collateral be insufficient.
A Non-Recourse mortgage, not surprisingly, means the opposite. The security for the loan would be the property itself. In most cases the Borrower would not be personally liable.
The Lenders Approach
In most cases, Canadian commercial real estate lenders structure mortgage loans so as to obtain full recourse from borrowers. Why? Quite simply it provides an extra measure of security, and mitigates risk. This recourse could take the form of either a corporate or personal guarantee, or both. In our blog post entitled Present Your Loan Request with Confidence, we introduced the concept of mortgage loan underwriting. This is the basis upon which a lender will provide your property financing. It involves :
i) determining that the property generates sufficient cash flow to repay the debt, and
11) that you’ve got the financial strength, capacity and expertise to effectively own and manage the property.
For institutional quality real estate lenders, the loan assessment bias is towards establishing the credit worthiness, and business acumen of the borrower. For this reason, full recourse has been the norm.
The Bad Boy Clauses
In our definition above, we referenced that in most cases, a Non-Recourse loan means the Borrower would not be responsible for debt repayment in the event of default. The lender would look solely to the value of the collateral. There are exceptions however. Some lenders have structured Non-Recourse loans, on the understanding that Recourse is available to the lender, should certain specified events occur. These specified events have been called everything from “Carve-Outs” to “Bad Boy” clauses. They can differ depending upon the situation, or the lender. The often include some or all of the following:
- Failure to maintain property insurance
- Committing a criminal act
- Committing fraud or misrepresentation
- Failure to pay property taxes, and
- Permitting Environmental degradation on/to the property.
Permitting one or more of these identified events would permit the lender to obtain full recourse to the Borrower.
What are Your Options?
Are Non-Recourse loans available to commercial real estate borrowers in Canada? Yes they are, under certain circumstances.
Key for a lender is the financial capacity of the borrower, their repayment track record, and the relative loan-to -value of the requested credit facility. Also important is the size and type of loan. For example, a construction mortgage for 75% or more, of the cost of building an apartment building, will most probably entail full Recourse to the Borrower.
Alternatively, a 30% loan to value on an existing commercial property, perhaps leased long term to a high quality nationally recognized tenant, with an experienced and well capitalized Borrower, would quite possibly not require recourse beyond the property itself.
Unsure of whether you qualify for a Non-Recourse loan? Its essentially to ask, during the application process. A savvy lender may consider your request, and provide you an option for a Non-Recourse credit facility, subject to a loan modification to address additional risk. This could take the form of a reduced loan, a higher interest rate, shorter amortization period, or other modification. Understanding Recourse vs. Non-Recourse mortgages is another important step in becoming an informed real estate investor.