Almost every commercial real estate transaction is accomplished by getting a mortgage instead of paying 100% cash.  The leveraging of a real estate purchase increases your return significantly (assuming it is a good purchase instead of a bad one).  However, if you fall behind in making your monthly payments or violate any of the other terms of your Deed of Trust, you may find yourself facing foreclosure.  A foreclosure is the ultimate bad outcome for a real estate transaction because not only does it end with the owner losing all of his equity in the property with the potential for being sued individually for any deficiency, but foreclosure has a very negative impact on the individual’s credit rating.  Missed payments on your mortgage can count for up to 35% of your credit score and a foreclosure will remain on your credit report for 7 years.  Not good!

There are 2 alternatives to foreclosure that all commercial real estate investors should be familiar with.  The first alternative is making an agreement with your lender for a loan forbearance.  The second alternative is to ask their lender for a loan modification.  These options are somewhat similar – the main difference is that a loan forbearance is temporary, but a loan modification is permanent. In both cases it is critical that the borrower set up lines of communication with their lender.  If all the lender knows is that their borrower is not making their required monthly loan payments, it is almost certain that the lender will file foreclosure.  If the borrower communicates with their lender about their difficulty in making payments it may be possible to negotiate a forbearance agreement or a loan modification.

A forbearance agreement occurs when the lender and borrower negotiate a temporary (written) agreement for the borrower to do one of several things.  The two most common terms found in a forbearance agreement are the following:  the borrower is allowed to skip one or more monthly payments and make up the deficiency at the end of their loan or the borrower negotiates a lower monthly payment with missed interest accruing until the end of the loan.  In many cases filing foreclosure has a negative impact on the bank lender because banks are under federal regulations and too many foreclosures can result in penalties being imposed against the bank by the FDIC or OCC.  With a forbearance agreement the borrower still is making some payments, and this causes less upset with the federal regulators.  The typical forbearance agreement might last anywhere from 3 to 6 months.  This agreement doesn’t allow the borrower to avoid making the payments, but it does give the borrower more time and gives them breathing room to get their investment in order.  If the borrower can keep the terms of the forbearance agreement, it allows them to avoid foreclosure which at the end of the day is the most important thing for an investor.

A more permanent solution is for a borrower to contact their lender, discuss with the lender why the property is having difficulty generating enough income to make their payments and try to negotiate a change in the loan terms. This solution is called a “loan modification” and once it is mutually signed, the terms of the loan are permanently altered.  The interest rate may be lowered, the loan maturity date may be extended, or the monthly payments may be lowered and a balloon payment added at the loan maturity.  Banks are motivated to do this for the same reason as they are sometimes willing to agree to a forbearance.   It keeps them out of trouble with the regulators, and, if their loan is “underwater” – that is the value of the collateral real estate has dropped below the amount owed on the loan – it allows the bank the chance to avoid taking a loss on their loan.  Banks, like every other kind of business, will try every possible way to avoid losing money and because real estate values fluctuate there are instances where taking back collateral in foreclosure that is worth less than loan principal is something to be avoided if possible.

The moral to this story is the importance for the borrower to stay connected with their lender.  The sooner the borrower communicates potential difficulty in making their payments to their lender, the better the chances for the borrower to be able to obtain a forbearance agreement or a loan modification and keep ownership of their property while avoiding a severe hit to their personal credit.

If you have questions about a hard money loan request, contact Montegra today at 303-377-4181.