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How a Bank Can Call Due a Commercial Loan Even Though It Is Being Serviced on Time

Posted by in Buying, Financing, Investing, The Economy

If you thought that timely payments on a commercial loan preclude foreclosure, think again.

The standard loan on an investment property had usually been a 20 year commercial loan which is not callable, with interest re-adjustments after each 5 year period.

Then lenders innovated.

Some lenders introduced balloon loans and promoted them with excitement.

The Perils of Balloon Loans

Balloon loans are commercial loans with a twist: they are still amortized over a period of 20 years with payments stretching over 20 years, but they can be called due after a period of twelve, seven or even five years. The lender still has the option to renew the loan, of course, but if they don’t, the entire outstanding balance comes due in a lump sum. Bang! If the borrower can’t pay, the lender can, quite obviously, foreclose.

On the upside, at least the paperwork says something to that effect.

But wait, there is another way to get surprised by your lender and it is when they get cold feet on an existing loan they deem not sufficiently secured.

Non-Performing Loans Redefined: Insufficient Security As Sufficient Cause for Calling a Loan Due

In the current meltdown of residential and commercial real estate, some lenders have been calling due commercial loans even though they have been serviced timely, by redefining them as non-performing. How can this happen? With falling real property prices, the bank might conclude that the security is insufficient and this alone can be grounds for calling the loan due.

Then there is the Due For No Reason clause.

Due For No Reason

In some agreements with banks (and hard money lenders) concerning the funding of commercial real estate you may come across the Due For No Reason clause. It means just that: the lender can call your loan due at any time, for no reason. Think it won’t happen? Think again. During the Loans and Savings crisis in the 1980s, it happened a lot. It can happen to you.

How to „Secure“ Your Commercial Loans and Protect Yourself from Lender’s Abuse

Do your homework. Read your fine print and have an experienced real estate attorney review it. Negotiate with more than one or two banks. It will cost you time but save you a lot of headache. Plus, don’t pyramid loans if you can help it. Pyramiding (not only in these market) exposes you and could bite you real bad.

But what if you have a loan with a twist already? Prepare yourself for the worst-case-scenario as good as you can. Line up a second, a third, a tenth lender in advance of the expected due date. Build relationships with several banks, now.

It’s a proven strategy. It has worked for none other than Donald Trump back in the early 1990s even though he was declared financially dead. Had he been dependent on one lender during his much-publicized brush with bankruptcy, he would have gone bust. He found himself almost a billion dollars in debt he had personally guaranteed and the media were celebrating his demise for public entertainment (much like he does nowadays on the Apprentice). What saved him is the fact that he owed the money not to one or two but to 99 banks, and negotiated like mad. He developed relationships on a first-name basis with every banker at each of his 99 banks. Paranoid? Maybe. As former Intel’s President, Chairman and CEO Andy S. Grove used to say, “Only the paranoid survive”.

Now, the size of most properties hardly warrants 99 banks. But being prepared can’t hurt. Do your homework and they will harass somebody else, not you.