Credit Partner Compensation

[Laurie F.]

I have a friend who is willing to be the guarantee on a HML for me so I can get better leverage/terms. His only contribution to the project will be his credit score but obviously he'll be on the loan. I'll be bringing the remaining funds, and managing the entire flip (my 7th).
What’s the typical compensation for this?

[Don Konipol]

I want to first state that it’s imperative that the guarantor realize that he will be personally liable for the entire amount of the loan in case of default, yet, have no control over the primary collateral.  This alone should make the potential guarantor realize that this is a TERRIBLE financial decision.

That being said a fair compensation for the risk is, depending on the risk, somewhere between 5 - 15 % of the amount being guaranteed.  Even that would feel way too low if the friend is called upon to make good on the loan.

Let’s review what actually happens from the guarantors experience   if the loan goes into default and see if you think your friendship can survive it

1. As a curtesy, the guarantor may receive a copy of the notice of default

2. The guarantor will be served by a process server naming him in a lawsuit charging a default on a loan

3. The guarantor will need to pay for a retainer to retain an attorney to answer the lawsuit, within the prescribed time frame

4. The guarantor will be served with a notice of foreclosure filing

5. Specific to the state the property is located in, either the foreclosure lawsuit will go to court, in which the guarantor will be a defendant and possibly be called as a witness to testify, or this step is skipped in a non judicial foreclosure state 

6. The property will be auctioned for sale.  If no one bids the lender will bid in a small amount to gain ownership.

7. The total amount owed, principal, interest at default rate, legal fees, processing fees, filing fees, foreclosure fees, etc. will be totaled and the amount the property sold for subtracted from this number.  The resulting balance wil; be the “deficiency”.

8. The guarantor will be named in a lawsuit seeking a deficiency judgement, will be served by a process server, and will need to hire an attorney for court representation.

9. Assuming no negotiated settlement is reached, the lender will receive a deficiency judgement against the guarantor.  This will appear as a judgement so all his non exempt property will be subject to seizure to satisfy the judgement and real property he owns will be encumbered by judgement lien.  His credit score will take a huge hit, any credit lines he has will probably be rescinded, and depending on the size of the loan and the value of his assets, may consider a bk filing. 

I know, I know, it’s a great deal and this will never happen.  Yeah, until it does.