Recognizing and admitting that there is a problem before it becomes an
even bigger problem is applicable advice for almost every aspect of life.
This approach becomes strikingly more relevant when financing a loan for
an unknown borrower.
As a lender, you have the ability to identify problem areas when underwriting
a loan that may indicate a future default. Most lenders depend on the
right to foreclose as a sort of safety valve to fall back upon. The right
is there, and as long as they have that right to foreclose, they assume
they are protected. Many lenders also assume that is less expensive to
react to a borrower’s default than to proactively address a loan
that is in the early stages of turning bad, or even before it funds.
For the most part, the assumptions are correct. Playing defense rather
than offense is more cost effective. Being able to foreclose on the property,
in most cases, is enough security to provide a loan. In a certain number
of cases, however, the mere right to foreclose will not suffice. Not all
foreclosures progress smoothly. While it is common that borrowers will
put up some fight against foreclosure, most do not have the resources
for long, drawn-out litigation.
There will be a certain number of cases, however, where foreclosure is
not an easy solution. Where the borrower will hold out and fight, possibly
delaying the foreclosure for more than a year. There may even be instances
where you will have to get or fight a court order to foreclose in the
first place. The borrower may find an attorney willing to work on the
come. Alternatively, the borrower may just be savvy enough to fight a
foreclosure action on their own, or at least prolong the agony. Many delaying
tactics can end up costing a lender tens, and even hundreds of thousands
of dollars to fight.
This is a reality. Not every defaulted loan will result in a smooth transition
So, by being proactive with every loan you fund, you can, over the long
term, save money, time and resources. Evaluating and identifying what
are deemed as “litigious borrowers” is a prudent way to prevent
getting caught up in a nasty foreclosure battle down the road.
How do you identify those borrowers that may force litigation after their
loan defaults? Well, they typically do not have construction experience.
If they are planning on doing a property flip and they are acting as a
speculator rather than someone with expertise in the construction trades,
this could be an indicator things may not turn out well. They may persuade
a lender to provide financing based on their promise to perform. Most
litigious people will say or do anything to get a loan funded. They have
no qualms about lying to get the capital they need for their project.
Not that all real estate speculators without construction background will
fail or cause you problems, but it can be an indication of possible problems
to come and their willingness to hold out if a default occurs. For whatever
reason, this is the type of person that will hang on to the security if
all else fails. They may find an attorney willing to place a lien on the
property in exchange for representation, or may take out additional loans
without the preferred lender’s permission. In each case, they will
fight you tooth and nail to defend the property from foreclosure.
Head off these problem cases out of the gate by thoroughly evaluating the
borrower’s project plan and by addressing these concerns:
What experience do they have buying and selling real estate?
Most successful flippers have sold multiple properties over the past 18
months. Ask for their sales history and take a hard look at their success rate.
How many projects have they completed in the last year? Last two years?
Last three years?
Many flippers and investors have completed multiple projects over the past
several years. The number of properties they have flipped should be a
good indication of their real estate background and knowledge of the local markets.
If they are planning on buying and holding or making tenant improvements,
what is their exit plan?
Find out what they intend to do after they buy the property. If they are
planning on flipping and the market drops, will they lease? Will they
sell? Learning the extent to which they are dedicated to the property
will give you a pretty clear indication of how hard they will fight you
to keep it after default.
What other assets do they have?
Determine the complete value of the assets they hold. Many times, a borrower
with lots of assets will put up less of a fight for one project that goes
bad, rather than a borrower who has placed “all their eggs”
in their one proverbial basket.
Who are their partners? How old are the relationships?
Many so-called litigious borrowers are charismatic and engaging. They tend
to bring other “partners” into their project by convincing
them they know how to run a successful real estate project. Find out who
their partners are. What background do the “partners” have
in real estate and construction? Have worked on previous projects with
the borrower? What will be the “partners” primary responsibility?
Talk to the “partners” and gauge their level of expertise.
See if the story of their relationship matches the borrower’s story.
Taking careful pre-project evaluation and investigatory steps can help
lenders learn more about their borrowers before lending them money, and
better determine if the relationship will be mutually beneficial or result
in drawn-out and expensive foreclosure litigation.
Contact the author
Paul Sievers for more information.