Bankers’ Hours column: what a personal debt guarantee really means
As the pandemic passes its first anniversary, many entrepreneurs and business owners are learning first-hand what a personal debt guarantee really means.
Most likely, this means that someone is demanding that you pay them money that you cannot afford. You personally promised to repay a loan to your business. But your business has been closed for months or is operating at 50% capacity or less; thus, there is not enough revenue to service the debt.
It doesn’t matter, says the lender: when you signed the documents, you put your signature stating that you are responsible, no matter what happens to your business.
Personal guarantees are common when borrowing money or renting property to run a business. We’re going to focus on borrowing in this space today.
Unless your name is, say, Microsoft, Facebook, or Apple, a condition of your business loan will almost certainly be your personal collateral. For a small business operator this can be devastating, as often no money has been taken out of the operation as the owner desperately tries to keep the ship afloat; the personal checking account can be as depleted as the store’s operating bank balance.
Banks, credit unions and savings banks (savings and loans) systematically require personal signatures, without exception. They want “skin in the game,” and bank examiners expect that. These lenders even require very good deposit and loan clients. Perhaps, rarely, they will give up the contingency if a borrower puts up additional collateral for the loan, and cash is often the only option. If the bank forgoes spilling ink on the promissory note, it could demand, say, 75% of the loan amount in cash, perhaps a pledged CD that would be immediately applied to the loan in the event of default. the borrower.
Which, of course, prompts the borrower to say, “What? Why would I want the loan if I have to tie up all my money! Whereupon the loan officer smiled sweetly, responding, “Exactly, Mr. Smith.” So just sign here on the note, and you can continue to keep your money here at the Second National Bank in Downriver Montana and withdraw it whenever you want.
What about hard money lenders? They look at the value of the collateral, so they can waive the collateral with a conservative loan-to-value ratio, right? Usually the answer is no. They want that skin in the game too. I’ve had discussions with some HMLs and heard some postulate the possibility of redundant oversizing, such as, say, 20% LTVR on building land, maybe 45% on a free and clean rental property and possibly a lien against debt-free equipment, but I haven’t seen such a scenario come true.
In fact, sometimes people with hard cash can seem downright conservative, especially in a booming real estate market like the one we are experiencing today. Many of these private lenders remember 2008 too well, when 50% of loan-to-value transactions turned almost overnight into 90% loans, and then, shockingly, transactions that were way short of water. 110%. So, many HMLs are hedging their bets, especially on super-jumbo residential properties that investors might buy to flip. Some diehard sources of capital wonder if the Big Fool theory doesn’t turn into the Biggest Fool law: you know, “I’m a fool to pay so much, but I’ll find a bigger fool to pay more.” “
So, one of these lenders could receive a flash cash request to buy a luxury home in Vail, with three contracts pending acceleration if the first buyer cannot meet a clause in the contract. This lender may decide not to rely on the contract price, or even a current valuation. Rather, there may be an underwriting decision to reduce the value, perhaps by checking the county appraiser’s latest estimate of “true value”, which is most likely a little below the current sale price. from the hot market.
We laugh at the joke that lenders want your firstborn as extra collateral.
But they would if they could.
Pat Dalrymple is originally from western Colorado and has spent over 50 years in the mortgage lending and banking business in the Roaring Fork Valley. He will be happy to answer your questions or hear your comments. His email is [email protected].