Loan Penalties: What do you use in your loan docs?

Question

Hey BP Private and Hard Money Lenders

I’m curious what penalties you typically include or consider including when lending to flippers/rehabbers on shorter term loans, and what you might charge when applying the penalty (understanding some state laws may have different rules)?

I am thinking of penalties in two ways but feel there could be many more:

• Late payment penalties during the term of the loan, perhaps 10% or flat $ amount based on loan.
• Penalties when the loan is extended beyond term.  This would be used to ‘encourage’ the borrower to close your loan out and move to another lender.  Perhaps charging points and/or doubling the interest rate or other approach.

Any and all details you can share based on your experience as a lender or even a borrower would be greatly appreciated.

And a shout out to @Keith Baker for inspiring this question through his Private Lender Podcast.com of the same name

Thanks,

Nghi Le · Answer

You guys are really gouging your borrowers on the fees there, and I speak as both an investor who has borrowed from a couple dozen different HMLs, and as a lender myself.

1pt/month is insane. Most of the national lenders that lend in PA are 1pt for 3-6 month extension, and these guys are lending at 12-month terms. We're even less than that, but our extensions are on a case-by-case basis. We'd rather set up loans for longer terms up front (ie 12-36 months).

If a loan is past its maturity date, that means something went wrong, and charging huge fees adds to their problem instead of helping it. I understand the need to motivate borrowers to pay off your loan, but trying to find ways to help them goes a lot further to building a long-term relationship (as opposed to them becoming a one-time borrower).

Of course, all of this depends on how your capital is set up, and the overall market there. I'm not sure what price points are in the areas where you lend. Most of my rental portfolio is in PA, ranging from $25k to $100k. The terms you guys are stating may make sense for $25k because nobody else lends at that amount, but at $100k it's not competitive.

Steve Hiltabiddle · Answer

@Nghi Le Thank you for your input and putting context around some of the nuances here. I agree wholeheartedly that if the project has turned south, it'll be like getting blood from a stone and it's better to find a path out in a timely manner so both parties can live another day.  My examples did not take that into account so I appreciate you putting a face to the borrower.

Hopefully staying on top of the project can help avoid late discoveries and my question was assuming a performing deal but where the borrower might be dragging feet to close out a lenders loan.

My intent is not to take a pound of flesh but have some recourse to get timely return of my investment so I can deploy again or get a proper return should unforeseen, but acceptable delays occur.

Odie Ayaga · Answer

I'm doing a poor job of explaining so I'll apologize. I appreciate you trying to get clear answers @Steve Hiltabiddle. I'm going to try to cover this in two scenarios because I know there are a lot of new investors who don't realize the first as well (I didn't either until I worked for a hard money lender).

$100K loan, 6 month term 12% interest rate vs 12 month term 12% interest rate:

Monthly in first situation is 2% (2K) and 1% in second situation (1K). Now let's say the investor goes beyond the agreed upon extension period and it's an extra 1 point thereafter (likely what the HML you mentioned meant when he said 3 point for 3 months). Every month thereafter until the extension period is up would be as follows:

First situation: 2%+1%=3K/month

Second situation: 1%+1%=2K/month

Also, you're nearby so I'd be happy to sit down and talk to you or talk over the phone if it helps as well!

Steve Hiltabiddle · Answer

@Odie Ayaga  thanks for clarifying.  I spoke to a HML who said he charged 3 points for an extension of up to 3 months. I don't recall if they bumped the rate up.

That's what I was envisioning but you're saying is if rate is 12% (1% interest only paid monthly), the penalty after a grace period could actually increase monthly amount to 2% of loan for remaining term (1% on loan and 1% for penalty).

Odie Ayaga · Answer

No it would actually mean if they passed that grace period the next month would be their normal interest only payment plus 1% of the loan and that would be the amount owed each month until the loan is closed out.

Steve Hiltabiddle · Answer

@Odie Ayaga  Thanks for your reply.  Let me see if understand this correctly based on what you shared.

Loan is for 6 months. Term sheet notes that to extend that term up to 3 additional months, a point is added for each additional month.  Borrower extends from 6 months to 8 months so they would pay and additional 2 points.   My terms also stated that for first month of extension, interest rate remains unchanged (1 month grace).  In this case, for 2 additional months, rate would be bumped up, say to 14%.

I understand it's all based on what is agreed but wanted to make sure I have the gist of your reply.

Question, if I do have a bump in the interest rate, am I to assume that bump would apply across the entire term of the loan and not be adjusted just for the final month (based on the above example)?

Original loan was 6 months for 10%.   Borrower repays after the 8th month so they would pay an additional 2 points for the extension and rate for the entire loan would then be 14%. If they had been paying monthly interest only at 10%, closing the loan out would require some payment in arrears I assume.

Thanks in advance for your reply,

Odie Ayaga · Answer

Extension fees are typically a point per month with a defined extension period. Many lenders have a grace period (1-3 months) with the same rates before that kicks in.

Loan Penalties: What do you use in your loan docs?

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