Recourse vs Nonrecourse Loan: What Construction Borrowers Should Know

In construction financing, the difference between a recourse and non-recourse loan can have major implications for a borrower’s personal liability. The issue is not only whether the property secures the debt, but whether the lender can pursue the borrower’s personal assets if the loan is not repaid.

Randy Efron of Skylatus Property Capital explains that if a loan is recourse, the lender can come after the personal assets of the borrower if the borrower defaults. If a loan is non-recourse, the lender generally cannot pursue the borrower’s personal assets and is limited to foreclosing on and liquidating the property that secured the loan.

For sponsors evaluating ground-up construction financing, understanding recourse, repayment guarantees, and completion guarantees is critical. These terms affect risk, pricing, personal exposure, and the lender’s comfort with the transaction.

What Is a Recourse Loan?

A recourse loan gives the lender the ability to pursue the borrower’s personal assets if the borrower defaults and the property collateral is not enough to repay the loan.

In commercial real estate, when people ask whether a loan is recourse, they are often asking whether there is a repayment guarantee. A repayment guarantee is the borrower’s guarantee to repay the loan.

From a lender’s perspective, recourse provides additional security. If the property value declines and the lender cannot recover the full loan amount through foreclosure, the lender may be able to pursue the borrower for the shortfall.

What Is a Non-Recourse Loan?

A non-recourse loan generally limits the lender’s recovery to the property securing the loan. If the borrower defaults, the lender can foreclose on and liquidate the property, but generally cannot pursue the borrower’s personal assets for a repayment shortfall.

From a borrower’s perspective, non-recourse loans are usually more favorable because they provide more protection from personal liability.

From a lender’s perspective, non-recourse loans involve more risk because the lender’s recovery is generally limited to the collateral. For that reason, non-recourse loans are usually more expensive than recourse loans.

How Repayment Guarantees Work

A repayment guarantee exposes the borrower to personal liability if the loan is not fully repaid from the collateral.

For example, assume a lender makes a $10 million loan. If the borrower defaults, the lender forecloses, and the property is sold for $8 million, there is a $2 million shortfall.

If the loan is recourse and includes a repayment guarantee, the lender may pursue the borrower’s personal assets for the $2 million difference. If the loan is non-recourse, the lender’s recovery is generally limited to the property, and the lender would absorb the shortfall.

How Recourse Applies to Construction Loans

Construction loans from banks are usually recourse. That makes sense from the lender’s perspective because construction loans involve added risk: the project has not yet been completed, the final value has not yet fully materialized, and the property may not yet be generating income.

Higher-priced lenders may offer non-recourse construction loans in some situations. However, because the lender is taking more risk under a non-recourse structure, the borrower should generally expect to pay a higher cost of capital.

This creates a trade-off. Recourse debt may be less expensive, but it creates more personal exposure for the borrower. Non-recourse debt may offer more personal protection, but it is usually more expensive.

Borrowers should evaluate this trade-off alongside the broader types of capital available for a project.

What Is a Completion Guarantee?

Nearly all construction loans, whether recourse or non-recourse, include completion guarantees.

A completion guarantee is a borrower’s assurance to the lender that the project will be completed on time, on budget, and in accordance with approved plans.

If the project costs more than expected, the borrower may be responsible for paying the increased cost out of pocket. This is why a completion guarantee is a form of recourse, even when the broader loan is described as non-recourse.

Why Completion Risk Matters to Lenders

Completion guarantees matter because a construction lender is making a loan based on the assumption that the project will be built as planned.

If the project is not completed as expected, the completed value that the lender relied upon may not materialize. In that case, the lender’s risk increases because the property may be worth less than anticipated relative to the loan amount.

One way lenders think about this risk is through loan-to-value, or LTV.

If costs increase or the project is not completed according to plan, the lender’s expected collateral position may become weaker. That is why lenders often require the borrower to stand behind project completion.

This is closely related to broader lender risk metrics, including leverage, stabilized value, and concepts such as debt yield.

Completion Guarantee vs. Repayment Guarantee

Completion guarantees and repayment guarantees both create borrower obligations, but they are not the same.

A completion guarantee is tied to finishing the project. It usually expires around the time the property receives its certificate of occupancy. A repayment guarantee, by contrast, is tied to repayment of the loan and does not expire simply because the property is completed.

For this reason, repayment guarantees are usually more burdensome to borrowers than completion guarantees.

Why Recourse Loans Are Usually Less Expensive

Recourse loans are usually less expensive because the lender has additional security. If the collateral is insufficient, the lender may be able to pursue the borrower personally.

Non-recourse loans usually cost more because the lender has less protection. If the property value declines and the collateral does not cover the outstanding debt, the lender may have to absorb the loss.

In construction financing, this pricing difference is especially important because the lender is taking on project completion risk before the final asset value is fully established.

Practical Takeaways for Construction Borrowers

Borrowers evaluating construction financing should understand exactly what guarantees they are providing and how long those guarantees remain in effect.

• Recourse loans allow lenders to pursue borrower personal assets after a default if collateral is insufficient.
• Non-recourse loans generally limit the lender’s recovery to the property collateral.
• Recourse loans are usually less expensive because they provide lenders with additional security.
• Non-recourse loans are usually more expensive because the lender accepts more risk.
• Bank construction loans are usually recourse.
• Some higher-priced lenders may offer non-recourse construction loans.
• Nearly all construction loans include completion guarantees.
• Completion guarantees generally require the borrower to complete the project on time, on budget, and according to approved plans.
• Repayment guarantees are usually more burdensome because they relate to repayment of the loan itself.

For sponsors evaluating construction financing, it may also be useful to review Skylatus’ broader property expertise, closed deals, and case studies.

Conclusion

The distinction between recourse and non-recourse loans is one of the most important risk considerations in construction financing.

A recourse loan can expose the borrower’s personal assets if the property collateral is not enough to repay the loan. A non-recourse loan generally limits the lender’s recovery to the property, but usually comes at a higher cost.

In construction lending, borrowers also need to understand completion guarantees. Even if a construction loan is described as non-recourse, the borrower may still be responsible for completing the project on time, on budget, and according to approved plans.

Skylatus Property Capital helps real estate sponsors evaluate construction financing, lender options, guarantees, and broader capital strategies for development projects.