When someone has defaulted on their mortgage, automobile loan, credit card, or any other form of unsecured debt it is called recourse debt. Secured debt, on the other hand, is debt that is secured by some type of collateral against the loan itself. This includes a promissory note, a mortgage, a land contract, or even a stock contract. Also referred to as a secured loan, this kind of debt allows the creditor to collect on the debt if the debtor fails to pay the debt and/or the creditor’s assets in favor of the creditor.
A good example of recourse debt is your car. If you are in a bad accident and your car is damaged beyond repair, what is the recourse debt in a partnership? You will have to prove that the loss of your car was your fault and that you did not have to pay for it through cash. If your automobile was worth more than your down payment, then you may be able to use this as your collateral. This would allow you to use your car as equity on your home, which would allow you to avoid paying taxes and the associated interest on your vehicle.
Another example of what is recourse debt in a partnership relates to personal loans. If your friend defaulted on a personal loan, the loan contract, including the balloon payment provisions, could allow the lender to go after your friend’s personal assets. For example, the loan contract could say that the lender can sell your friend’s car if the borrower fails to make his payments. While the tax implications of this might be understood, it would not follow that you would not be personally liable for the tax liability. You could still end up owing tax on the amount of the balloon payment, even though your friend has gone.
The most common example of recourse debt in a partnership relates to credit cards and mortgages. Suppose you are in a car accident and you need to take advantage of a credit card to buy groceries. The loan agreement could specify that you repay the entire principal, including interest, even if you have to pay for a portion of the car damage yourself. If your friend defaults on his or her credit card payments, the lender can file a claim against your personal assets to recover the principal balance.
Another example of what is recourse debt relating to federal income taxes. If you owe back taxes on an inherited estate, your tax consequence could come from the estate itself, not from the loan. This is called nonrecourse debt. Your tax consequence will be limited to the tax due on the inherited estate. With nonrecourse debt, the lender does not have the option of claiming a large amount of the inheritance as tax relief.
Most borrowers are familiar with the concept of recourse debt. However, many do not understand how much of a liability they are exposed to when they fail to repay their loans. Nonrecourse debt only refers to debts that borrowers do not have to repay in the event of default. If the borrower takes out another loan to pay off his existing recourse loan and later neglects to make payment, the second loan is also considered nonrecourse debt. In this case, the borrowers are exposed to both loan balances, even if they do not default.
There are some borrowers who may be uncertain as to what is recourse debt in a partnership. Borrowers must remember that the definition of nonrecourse debt actually applies to loans that are used to purchase property that becomes the liability of the partnership. Property purchased using a loan may bequeath a lien on the partners’ business.
This means that if a borrower defaults on a recourse debt, the lender has to either foreclose on the property held as collateral or take the borrower’s car or other property intoossession. The borrower has no say in the process as the lenders are acting on behalf of all lenders collectively. Thus, the borrower is personally liable for any costs incurred on the property while the owner of the asset is removed from his or her home or business due to foreclosure. Learning more about the concept of recourse debt in a partnership may be helpful for individuals who own property and wish to better understand how their business is regulated by law.