I apologize in advance for the long post but this is important information to have and I don’t want to leave anything out.
Recently, I have been seeing a lot of borrowers who were trying to pay off loans that had unfavorable loan terms that were causing them problems.
Honestly, I would call some of them predatory but the lending laws that define predatory lending don’t apply to business purpose loans so even if these terms are unfair, they are still legal in most cases.
Here’s what to look out for:
1) Default rate: a default rate is when the interest rate goes up in the event that you go into default on your loan. It can be triggered when you become late on the loan or when the balloon payment is past due. Depending on how it is written, it can be reduced back to the original rate when everything is paid current or it may stay at the higher rate until the loan is paid off. I have seen default rates where the interest rate went up by as little as 4% or by as much as 12%.
If you have had a lot of recent late payments, you may end up with a default rate but don’t accept one that you can’t deal with or one that keeps the default rate in effect even after you have paid everything current. The problem with a default rate that can’t be reduced is that it makes it incredibly difficult to make your payments, especially if your payment is increased by 50% or 100%.
2) Late payment penalty on a balloon payment: When a balloon payment is due and isn’t paid within the grace period that is granted on each other payment on the loan, some lenders charge a late payment penalty just as if the balloon payment were a normal payment.
This could be 10% of the loan amount which can make a huge difference and can make the difference between being able to refinance and losing the property in foreclosure. For example, if you borrowed $400,000 and there was a 10% late fee on your balloon payment. your penalty would be $40,000.
3) High attorney fees on a foreclosure: For California properties, it isn’t necessary to have an attorney involved in a foreclosure but some lenders do it anyway. This can add thousands of dollars in fees the borrower has to pay.
I just closed a loan for a borrower whose balloon had come due and the lender not only started the foreclosure process but also had an attorney involved. In addition to approximately $2,200 in foreclosure fees, there were over $14,000 in attorney fees which were entirely unnecessary. I can’t tell you who the lender was here because I don’t want to get sued but if you are getting a loan and want to know what to watch out for, I would be happy to tell you.
4) High loan fees: This one is very subjective but if you are paying over 5 points in fees and it isn’t a small loan, you can probably do better without trying very hard.
And if your loan includes a bunch of different fees, that could be an indication that you are being charged too much. We normally charge a processing fee and a document preparation fee but if you are also seeing things like an inspection fee, funding fee, document review fee or various other fees that you may not even know what they are really for, that may not be the place to go for a loan.
How you can avoid these things:
1) Make sure to read and understand the terms of your loan. If you don’t understand something, look up the words you don’t understand in a dictionary until you do understand what it says. A verbal explanation from your loan officer won’t change what it really means and the loan officer may not understand it either.
2) Don’t wait until the last minute to refinance your loan. The way a lot of these bad loans end up getting done is when a borrower is running out of time and doesn’t have any other options so they take whatever they think they can get.
Knowing when your loan is due or when it needs to be refinanced can save you a lot of trouble and money. I recently read the terms of a loan done by another broker that gave the broker the ability to automatically extend the loan for 6 months at a time and to charge the borrower 1.5 points (equal to 1.5% of the loan amount) each time they did it. At that point, they had made an extra $25,000 off of that borrower.
3) Make sure the loan will work for you. Even if it is a temporary solution, it is vital that you know you can meet the terms of the loan and, if necessary, get out of it and into a better loan as soon as possible.
Even if you are in a tight spot, it doesn’t make sense to take a loan you either can’t make the payments on or can’t get out of. You would probably be better off selling the property and getting your equity out of it.
4) Don’t believe anyone who says you have no choice but to accept their offer. It is incredibly rare that there is only one lender who will do a loan and most loan officers who tell you that you don’t have any choice are really just using pressure tactics to get you to do the loan.
This is a classic shady sales tactic and usually tells you the loan officer is not really on your side. They may only have one option for you but if you don’t like it or it doesn’t work for you, don’t take it.
5) Do everything you can to keep your mortgage payments current. This will help to put you in a position to get a better loan and not have to deal with any of these terms. However, some lenders who offer lower rates will still include some of the terms listed above.
My preferred lender for non-hard money alternative loans offers 30-year loan terms instead of short term loans with default rates and other potentially predatory terms. What this really means is that there are options and you don’t have to take a loan you don’t like just because it is the only thing being offered.