Limit The Security You Grant to Your Lender

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Security

IN MY LAST ARTICLE, you read about the various securities lenders can take over your property, in addition to mortgages.

This article will highlight various options for improving your security position when borrowing as a means of maximising your asset protection.

Limit Guarantees

Most borrowers investing in commercial property are concerned primarily about the rate and fees attached to their loan. However, you should also look at the consequences of a default and the effects on your other assets.

In most cases (although not all), it is necessary to provide personal guarantees when borrowing for a mortgage. But it best to avoid offering the lender security above what is required to get the loan.

Before you accept any loan offer, it is a good idea to be aware of the security required by the bank and where possible, limit this guarantee.

A few ways you can achieve this, include:

  • Limiting personal guarantees to the value of the property offered as security;
  • Ensuring no “all monies clause” is attached to your facility; and
  • Removing any unnecessary personal guarantees (for example, spousal guarantees where the spouse is not a direct party to the loan)

Non-Recourse Borrowing

In some situations, when borrowing for a commercial property purchase, it may be possible to provide no personal guarantees.

This type of borrowing is called a “non-recourse” loan.

With these loans, the servicing capacity for the loan needs to be covered by the rental from the property itself. And the loan-to-value ratios are therefore lower, than for traditional loans providing extra security.

This type of borrowing is typically useful for large syndicates or property trusts, but few “mum and dad” investors realise that these facilities may also be available to them. So, talk with your finance broker about this type of loan.

Limit “Default” Clauses and Covenants

You may think that for a loan to be in default, the borrower needs to fall behind in loan payments. But this is not always the case.

Lenders, and banks in particular, will often insert clauses in a loan contract that may trigger a default in situations such as:

  • Financial ratios not being met (common with owner occupied businesses)
  • Valuations on properties resulting in higher LVR
  • Certain amounts of rental not maintained

As such, in order to minimise the risk of default, it is important that you look for a loan facility that does not have onerous covenants.

If you are seeking riskier loans such as cash-flow loans and development loans, then it may not be possible to avoid such covenants.

However, you will do better if you keep your loan details as simple as possible.

Minimise Annual Reviews Where Possible

A loan facility that requires annual reviews means added expenses.

With these loans, there is also an increased risk of default. Due to the fact that low valuations and lower income years may trigger your lender to chose to exit the loan facility.

Once again, it is not always possible to avoid annual reviews. But it is certainly worth exploring loan options that do not require such reviews — when choosing the best loan for your investment.

Look at the loan term

Shorter loan terms mean that your loan is up for a review after shorter periods of time.

BOTTOM LINE: To ensure that you maximise your asset protection, it is vital that you understand what type of guarantees you are providing the bank.

Before deciding on a loan, review all the options available to you; and choose the loan with most favourable terms. But remember, this doesn’t always mean the cheapest interest rate.

Finally, you should always seek professional advice — to ensure you are protected from the outset.

Perry

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