Every borrower dreads the word “foreclosure.” No none wants to think about it or have to deal with it but it happens. It’s a reality both lenders and borrowers have to contend with from time to time; and hard money lending is no exception.
If you are considering private money for your next project, you need to realize that private lenders are likely to make moves to foreclose faster than banks should there be a breach in terms of the promissory note or trust mortgage deed.
Why You May Have To Decline A Hard Money Loan
You’ll need to carefully weigh your options and consider the fact that you could lose your collateral if you are unable to fulfill your loan obligation for some reason. Sometimes, the reasons borrowers fall short may be as basic as not properly understanding what they were getting into at the beginning. That’s why it’s important to read through your loan documents carefully before you sign.
If you’re still unsure, get a counsel to check your loan documents and review the transaction before you sign. After a careful analysis of the requirements if you think you can’t keep up with the monthly payments, or you can’t meet some of the terms, or you can’t afford the loan as a whole; please back out.
In case you don’t know, private money loans fall outside of the typical consumer protection guidelines you can get when obtaining a residential owner-occupied loan. This is because they are mostly loans for business purposes.
Why Hard Money Lenders Foreclose Quickly
Let’s look at the nature of hard money loans before we examine the different ways lenders can foreclose different types of loans, including hard money loans. It will help you understand why private lenders may seem more aggressive about getting their money back.
As you probably know by now, the money you get from hard money lenders does not come from the banks. It comes from individual investors, a group of investors or a corporation. These are investors like you that are looking for returns on their capital. To get these returns, they will approach reputable private lenders to connect them with borrowers such as yourself.
The money these investors give you is not insured by the FDIC. Any hope they have of getting their money back lies with you and your fulfillment of the loan. Also, they can’t just walk into a bank and get their money whenever they choose. As a result of these risks, hard money loan rates and costs are higher than conventional loans. The lender is also under pressure to maintain his reputation and relationship with the investor; he/she will move quickly and take prompt steps to get the money back if they notice any “warning signs” at your end.
Reasons Lenders Could Foreclose On Hard Money Loans
When borrowers consider foreclosure, the first that comes to their minds is that as long as they don’t default on payment, the lender has no reason to foreclose. This is far from the truth and is a common mistake that could cost them dearly.
There are many reasons why a lender may decide to foreclose such as:
- Defaulting on payments as agreed. This remains the most common reason for foreclosure.
- Call Loans. The lender is allowed to review the financial position of the borrower at intervals based on certain covenants included in the promissory note. The lender can call the loan due and payable if they perceive that the borrower’s financial position has deteriorated and as such the borrower can no longer fulfill the terms as agreed in the original loan documents.
- Balloon Payments. Many hard money loans are in the form of balloon payments. The borrower is expected to pay a substantial part or all of the principal at a specified time in the future. It may be at the end of the loan term or sooner. For instance, you take a loan that is amortized over a 15 year period allowing for lower monthly payments that you can easily cope with. But there is an impending balloon payment due five years down the line. If for any reason you can’t make that payment, the lender may choose to foreclose, and you will lose your collateral.Borrowers should always be wary of the kind of balloon payment agreement they accept because circumstances at the beginning of the loan could change and prevent them from meeting up with the payment obligations later.
- Not meeting up with the maturity date. This happens if a borrower is unable to pay when the loan is due and payable. Such scenarios are common with short loans like short-term bridge loans with a maturity date in as little as 3 to 6 months or a year.
- Defaulting on loan covenants. Hard money commercial loans are structured with different types of financial covenants like debt-to-equity ratios, minimum working capital, and non-monetary covenants like restrictions on substantial changes to the type of business the borrower uses the property for.
- Willful waste. The lender may have the authority to foreclose if the value of the property deteriorates due to lack of, or inadequate maintenance.
- Illegal/unauthorized transfer of ownership. Your loan may become due, and you will be required to pay in full even when the maturity date is not due if you deed the ownership of the property to another entity without obtaining the consent of the lender first. This applies regardless of if you received money for the transfer or not and is also known as a due-on-sale clause.
- Unauthorized junior liens. Borrowers will usually be required to obtain permission before adding junior financing, such as a second mortgage loan. Obviously, it could affect the borrower’s ability to still pay the senior lien if their financial situation deteriorates.
These are just a few situations in which a lender could foreclose on your property regardless of the fact that you are making the agreed payments when due.
Luckily, hard money loan transactions are highly negotiable, so if you know ahead what could go wrong, you’d be in a better position to protect yourself and your assets. The best way to do that is to read the promissory note carefully. Make sure you check the implications of every covenant before you sign because ultimately, foreclosure is an inconvenience for the borrower (you), the lender, and the investor. The lender and the investor have no interest in taking your property from you. Don’t force them to.