Hard Money Loans and Foreclosures
So think carefully before obtaining the loan and understand that the collateral you offer may be forfeited if you do not live up to your end of the proverbial bargain. If you cannot afford the loan, or meet the loan covenant terms, or pay it back when specified, it’s best not to obtain the loan. Loan documents can be voluminous and sometimes difficult to understand. Private money loans are almost always loans for business purposes and fall outside of many consumer protection guidelines you may be accustom to when obtaining a residential owner occupied loan. Always obtain counsel to review your loan documents and assist you in the negotiation of your transaction.
A common misconception by borrowers is that a lender can only foreclose if a payment is not made. This is not true. Lenders, whether bank or private money, can foreclose for a variety of reasons, many of them having nothing to do with a monthly payment. The servicer of a hard money loan will foreclosure much quicker than the servicer of a bank loan because there is a private investor who will be more diligent than the bank.
Before we consider ways lenders can foreclose on all types of loans, including hard money loans, it would be helpful to understand the nature of private money loans in the context of foreclosure. Private money loans don’t come from banks, they come from private money lenders. Sometimes the lender is a corporation, but that corporation is typically made up of investment from people just like you and are just looking for an added return on their capital. These investors will likely request the assistance of an experienced loan professional (the private money lender(PML) to place their investment with a well meaning borrower like yourself. There is no FDIC insurance, the investor cannot go to a bank teller window and withdraw their funds whenever they choose. The investor’s future return, and capital, is tied to your performance on the loan. Their ability to get their invested capital back is tied to you. Because of these risks, they demand a higher return which translates into a somewhat higher interest rate and up-front costs for you as the borrower. Because of these risks, the investor is depending on the private money lender to take quick and prompt action if the loan is breached.
So now that you understand a bit about who and where the actual private money capital comes from to invest in your loan, you may be able to appreciate a bit more about why private money lenders may be more aggressive about getting funds back for their investors, especial on hard money loans.
Reasons Private Money Lenders Could Foreclose
Payment – The most common reason is a default in the agreed upon payment as detailed in the promissory note.
Balloon – Many private money transactions have a balloon payment provision where some or all of the balance is due at some time in the future, but far prior to the term used to amortize the loan. A common scenario is for a loan to be amortized over a 30 year period to allow for lower payments, but have a balloon payment due in 5 years. The lender will have the right to foreclose if you cannot make that balloon payment when agreed. Be careful about agreeing to make short term balloon payments because your financial circumstances or the financial environment may change and could prevent you from refinancing or selling your property to meet your balloon payment obligations.
Maturity Date - The maturity date is the date your loan is due and payable. If you get a short term bridge loan, your maturity date may be in as little as 6 months or a year from now.
Call – Some note provisions give the lender the ability to review the financial condition of the borrower based on a variety of covenants included in the loan documents. If the lender determines the borrower’s financial condition has deteriorated and no longer meets the covenants set forth in the original loan documents, the lender may call the loan due and payable.
Waste – Some security document provisions give the lender the ability to advance funds, or even foreclose if the value of the property is deteriorated due to the lack of upkeep or repairs.
Covenants – Most hard money commercial loans come with loan covenants which specify various financial ratios and other non-monetary related issues. For example, the lender could require that your business maintain a certain level of equity, or that the property value may not go below a certain amount over time, or that the debt service coverage ratio be maintained over a certain level.
Illegal transfer – If you deed the property to another entity without the consent of the lender, your loan may become due and payable in full regardless of the maturity date. This is also know as a “due-on-sale” clause. The transfer of the property is viewed as a “sale” whether you received monetary consideration or not.
Illegal junior liens – Many commercial loans require that borrowers obtain permission before adding junior financing because it could dilutes the borrower’s ability to pay the senior lien in the event their financial situation changes.
Investors in private money are not after your property. Most investors make a hard money loan for the fees and interest and they want to service it for the fee income for as long as they can. But the private money lenders do have a fiduciary duty to protect their private investors’ collateral which is why they will be obligated to act, and act quickly if you are in breach of your loan agreement.
The above are just a few of the examples of how a private money lender may be able to foreclose on your property even though you may still be able to make the agreed upon monthly payment.
All terms are negotiable in a private money transaction for hard money loans. Carefully read your loan documents, make sure you can comfortably achieve the loan covenants, and be aware of balloon payments that may be due, or maturity dates which will require you to repay the loan.
Search for hard money loans in our directory of private money lenders.