Hard money loans for commercial purposes will usually be full recourse. In addition, the lender will require a guarantee that no matter the circumstances, the borrower will repay the loan (a full recourse personally guaranteed loan). Full recourse, personally guaranteed hard money loans give the lender confidence that you are dedicated to the success of the project. This is also known as “having skin in the game.”
Note that a full recourse loan is not the same thing as a guarantee and they both have different legal implications.
Types Of Hard Money Loans
A private money loan can either be a full recourse loan or non-recourse loan.
- In a full recourse loan, if the borrower were to default or the collateral does not fully settle the debt, the lender is permitted to pursue the borrower to collect on other assets owned by the borrower. To protect themselves against this, many borrowers title their assets in separate entities from their personal name.
- In a non-recourse loan, the borrower is not held personally liable for repaying the outstanding balance on the debt. Though, there are exceptions to the rule known as carve-out provisions.
For illustration, let’s say a borrower approaches a lender for a hard money loan and uses a shopping mall that is titled in his name as collateral. They strike a deal, and the lender gives him a full recourse loan but without a personal guarantee. If the collateral asset securing the loan has to be liquidated but falls short of the total loan amount, then full recourse allows the lender to sue the borrower for the shortfall. In this instance, the loan is similar to a personal guarantee and the borrower is exposed on all other assets titled to him personally.
If the borrower in the above example had owned and titled the assets through an LLC, and secured the loan through the LLC, the lender can only claim compensation to the extent of the value of the assets owned by the LLC.
In essence, a full recourse loan is restricted to the borrower’s personal assets. As a result of this, to improve their risk position, the majority of commercial lenders will demand a personal guarantee from a potential borrower and even include assets of other related entities too. Doing that will allow the lender pursue more alternatives to recover their money.
There are three types of guarantees: unlimited, limited personal and conditional personal guarantee.
- Unlimited personal guarantee. The guarantor guarantees 100 percent of the loan amount plus other costs like legal fees, accumulated interest and any other costs incurred while trying to recover the loan. For example, if you owe $6,000 and the lender spends $500 in legal fees to recover the loan, you now owe $6,500.
After foreclosing on the collateral, if there is still some debt outstanding, the lender will go after your other personal assets to make the loan good.
- Limited personal guarantee. This type of guarantee sets a dollar limit on what the lender can recover from you in the case of default.
It’s more common where several partners, or shareholders, take out a company loan together. However, a limited guarantee will often include a fraud clause or “bad boy clause” that converts a limited guarantee to an unlimited one where there is proof of fraud.
- Conditional personal guarantee. This is not enforceable immediately after default, but there must be a trigger event to take make the guarantee valid. In such cases, there are specific conditions the borrower must beach before the guarantee can be invoked.
The Owner Of The Note May Change.
It’s not necessarily the private lender or investor you are dealing with that will enforce the guarantee. Don’t make the mistake of assuming your cordial relationship with the person negotiating your loan will automatically buy you leniency if things go wrong.
A lender may decide to quickly sell a non-performing note and cut his/her losses so the owner of the note can change at any time. You’ll need to have that at the back of your mind and consider that at some point in the transaction, you may find yourself dealing with a complete stranger that will go to the full extent of the law to collect if you default or violate any of the loan conditions.
When you have this kind of knowledge in advance, it will make the loan transaction more favorable for you since you will be in a better position to negotiate terms like guarantees, etc. Check the different aspects of your loan and work with your lender to create an agreement that is advantageous for every party; the lender, the investor, and the borrower. Fortunately, hard money lending is highly negotiable, and it easily allows for such favorable arrangements.