You’ve given your personal guarantee on a mortgage. Do you know what the implications are?
Personal guarantees are a common form of security. This is true for all commercial lenders extending credit to all forms of businesses. Commercial mortgage lenders are certainly no different.
Real Estate investors incorporate to shelter themselves from personal liability arising from their business operations. This is both recommended and entirely appropriate. Lenders know full well that in situations of default, shareholders are protected behind the “corporate veil”. The lender has no recourse in such circumstances, to the corporate shareholders and directors, for any shortfall.
Consider your obligations carefully
Why is your personal guarantee required? To prevent any likelihood of loss, commercial mortgage lenders will often require a personal guarantee from one or more individuals. This provides additional lender security above and beyond the value of the mortgaged property. From your perspective this might be a “belt and suspenders” approach to lending. Known alternatively as a “recourse” loan, the benefit for your lender is that this debt repayment also then becomes a personal obligation. A personal guarantee is an obvious additional safety net for your lender. Its often one of many legal documents signed by borrowers when new credit arrangements are made, only to be forgotten shortly thereafter. Rest assured, your lender has not forgotten!
A significant obligation
Offering your personal guarantee on a commercial mortgage, is a significant financial and legal obligation. You are putting your personal assets on the line when you sign a personal guarantee. How much risk can you live with? Its important that you consider this carefully.
Are you guaranteeing with others?
If you co-own a property with another individual, is your personal guarantee Joint & Several? A Joint & Several guarantee implies that the lender does not have to pursue each guarantor equally. They can secure the entire debt from one guarantor if they so choose. A Several guarantee is different. It limits the ability of the lender to secure only your obligation. In an equal ownership situation, that might imply 50% of the debt owing.
Is your guarantee limited?
Are there any limitations on your guarantee? If not, then presume that it is an ongoing obligation! If you are able to do so in advance, review, together with your lawyer, the proposed guarantor documentation and wording carefully.
6 Tips You Should Follow
On the premise that all terms are negotiable, consider the following strategy:
- Limit your personal guarantee obligations to a lesser amount. Typically a lender will seek to have you personally guarantee the entire amount of the indebtedness. Frankly, the “at risk” portion of the loan is the top piece. Seek to limit your exposure to an amount less than the entire amount of indebtedness. Even an empty building will have some value to the lender!
- Limit your personal guarantee to a percentage of the amount of indebtedness, so that it falls away (reduces) as the debt is paid down.
- Negotiate a release of your personal guarantee once the loan to value (LTV) reduces to a specific point, or a specific amount of the loan has been repaid.
- Negotiate a release of your personal guarantee in the event that the property is sold and the current financing is assumed by a new purchaser. This is a fairly common oversight of property vendors. They assume that since they no longer own the property, they’ve wiped their hands of it. Not so, if the purchaser has assumed the debt you originally guaranteed.
- Discuss the need for the personal guarantee with your lender. Consider borrowing a lesser amount, (lower LTV) or perhaps consider paying a higher rate, or taking a shorter term, if this alleviates specific lender concerns.
- If the guarantee is required so as to mitigate risk associated with a particular property issue (e.g. impending lease maturity), consider an alternate way to provide your lender with comfort. Perhaps a Letter of Credit (L/C) which the lender could cash (and reduce their indebtedness) in the event that the tenant fails to renew their Lease. Keep in mind this L/C, if cashed, becomes an ongoing credit obligation.
Personal guarantees are a recognized real estate lender requirement. Unless your covenant is undoubted, and you have several significant sized loans with the specific lender, your personal guarantee will likely be required. Speak with your lender and understand why this is being requested, and negotiate a more favorable guarantee provision. Sleep better at night!