Let the Borrower Beware!
In this booming economy, you may be interested in refinancing the debt on your commercial family. You may have even contacted one of the handful of mortgage brokers who specialize in such refinancing loans.
Your first concern is, of course, which interest rate is being offered? What are the repayment terms? Can you get cash out of the loan? How can you qualify for the loan? These basic loan considerations should only be the beginning of your inquiry, however. Once you have approved the basic financial terms of your loan, you will receive a rather voluminous loan package, containing numerous documents drafted by the lender’s sophisticated attorneys. These documents contain many traps for the unwary borrower, with hidden features and charges, as well as restrictions on the manner in which you may conduct your business during the term of the loan.
If you have consulted with a loan broker to obtain your refinancing loan, remember that the broker usually working for the lender and receives his or her commission from the lender only if the transaction is consummated. The broker may not be motivated to negotiate on your behalf with respect to hidden fees and charges, or the legal pitfalls in the loan documentation.
The following is intended to constitute an overview of a typical refinancing loan. It is not, however, nor should it be construed, as legal advice for your particular situation. You can and should consult with an attorney to assist you in understanding and negotiating the terms of your particular loan.
YOUR LOAN APPLICATION?
The first step in obtaining your refinancing loan, whether through a broker or directly with a lender, is a submission of your loan application. WARNING! This is the most important document in your loan transaction. It is also the most often overlooked. The loan application may be presented to you as a ‘mere formality”. But its language, and more significantly, what may be missing from the loan application, may serve to undo much of what the borrower seeks to accomplish by the loan.
The borrower is generally required to invest significant sums of money at the time the loan application is closed, including fees for appraisals, engineering reports and environmental studies. These expenses can often run in the tens of thousands of dollars. Before committing this money by submitting your loan application, you and your counsel must be sure that all of the following issues are addressed in the loan application.
- Loan Terms. The financial loan terms, including principal amount, interest rate, payment date(s), grace period, late charges and the default interest rate.
- Rate Lock. The borrower should negotiate a “rate lock”, that is, the lender’s promise that the interest rate shall be agreed upon, and fixed, provided that the loan funds by a specified date.
- Costs and Expenses. All of the costs and expenses which the borrower is expected to pay in connection with the loan approval process should be set forth in the loan application. Depending upon the situation, the borrower may be able to negotiate a cap on the amount of all or part of these fees and expenses.
- Security/Recourse. In most cases, the facility itself will secure the loan, either by way of mortgage or deed of trust. Additionally, the lender may require the owner to assume personal responsibility for the loan. This is a crucial aspect of the loan negotiations. In many cases, it may be possible to negotiate the extent of the owner’s personal liability.
- Loan Assumability/Transfer of Interests. The extent to which the loan is assumable, and/or whether the owner is permitted to make certain transfers (i.e., to family members or to investors) without jeopardizing the loan, should be specifically addressed in the loan application.
- Prepayment Issues. If the lender intends to securitize the loan, and in certain other cases, the lender may require a prepayment penalty in the event that the loan is paid prior to maturity. In such cases, careful attention must be paid to the loan application as to the terms of the prepayment penalty clause. By way of example, consideration must be given to possible prepayment not only in the event of a sale or transfer of the facility, but also in the event of condemnation or a casualty which results in the full or partial destruction of the facility.
- Loan-to-Value and Cash Flow Verification. Inevitably, your loan will be subject to the lender’s verification of the loan-to-value ratio of your property as well as verification that your facility satisfies the lender’s debt service coverage ratio. The better these numbers are, the better able you will be to negotiate more favorable loan terms. It is essential that you and your counsel review and understand the formulas used by the lender to determine your facility’s loan-to-value ratio and cash flow.
- Insurance and Impounds. The lender’s requirements for insurance coverage and impounds for taxes and insurance should be spelled out in the loan application. Oftentimes this aspect of the loan is overlooked, and the borrower receives several nasty surprises in the loan documentation supplied by the lender.
- Supporting Documentation. In order to hold the lender to its obligations under the loan application, the borrower should insist that the lender include, as part of the loan application, a detailed list of the documents to be provided and conditions which must be satisfied by the borrower before the lender will issue its loan commitment. This will prevent the lender from later making unnecessary and unjustified demands for additional documents and/or conditions to prevent the lender from later attempting to change the loan terms or simply refusing to fund the loan.
- Appraisals and Reports. To the extent possible, the borrower should attempt to negotiate fixed amounts, or at least “cap” the fees to be paid to the various appraisers, engineers and consultants to be employed by the lender. In many cases, it may be possible to participate in the selection of the appraisers, engineers and consultants.
REVIEW OF LOAN DOCUMENTS
Congratulations! Your carefully negotiated loan application has been accepted by the lender. The lender’s appraiser, engineers and consultants have verified that your facility meets the lender’s qualification requirements, and you and your counsel have received the lender’s rather hefty loan package and its voluminous legal documentation. The package will include your promissory note, and the deed of trust or mortgage documents securing the loan. The package may, depending on the nature of the transaction and its situs, also include a hazardous substance indemnification agreement, a proposed attorney opinion letter, financing statements and/or escrow instructions. These documents must be carefully reviewed to assure that they comport with the terms of the loan application. Your loan documents will invariably contain a clause that states that they are the final agreement of the parties. If there is any variance between the terms of the loan and the terms of your final loan documentation. It is not uncommon for the loan package to vary, by inadvertence or design, from the terms of the loan application.