Below are a list of common lending terms to be familiar with when making a loan. Many of these terms appear on our standard document request form that we require clients to fill out prior to drafting loan documents.
Amortization: The accounting technique used to periodically lower the book value of a loan over a set period of time. If a note “amortizes,” that means that a partial payment of the principal is being repaid with each interest payment to the lender over time versus all upon the loan’s maturity date.
Balloon payment: The monthly payments are of interest only, and a repayment of the outstanding principal sum is made at the end of the loan period.
Collateral property: When a Borrower’s asset is used to secure a loan, then the loan is collateralized. Collateral offers the Lender an alternative source of repayment. In the event that the Borrower defaults on their loan repayments, then the Lender may take ownership of the collateral property subject to the loan terms.
Default rate: If the Borrower fails to make their payment when due, or another event of default occurs (such events will be outlined in the loan documents), then the default rate will be applied on the outstanding interest until the default has been remedied or cured. This rate is higher than the typical interest rate to serve as an incentive for the Borrower to quickly cure their default to avoid paying the higher interest rate.
Events of Default: Certain events which are outlined in the loan documents will constitute as a default under the loan and thus trigger the default rate, or in some cases, can be grounds for the lender to declare the entire loan in default and accelerate the loan (call for the entire principal to become due immediately). Common events of default include a non-payment, violation of agreed covenants, and incorrectness of representations and warranties.
Guarantor: A third party that is agreeing to become personally liable to the Lender for the repayment of the loan should the Borrower fail to make their payments. The Guarantor cannot be the Borrower because the Borrower is already personally liable for the repayment of the loan. However, the Guarantor can be the manager or president of a business because if the Borrower is an entity, the entity is personally liable for the loan, not the manager or president.
Interest Rate: An annual interest rate will be specified such as “9% per annum, payable on the outstanding balance.” The interest rate should also specify how the interest payment is to be calculated (e.g. annual interest rate times actual days elapsed/365 days).
Lien Seniority: Describes the liquidation priority position of a lien relative to the other indebtedness on the property. The more senior the lien, the higher priority the loan has when the credit obligations of the Borrower are being paid from the proceeds generated through asset liquidation. Our Lenders typically require first position liens. We strongly advise against anything lower than a second position lien because then the Lender’s investment will not be strongly protected in the event of a foreclosure on the collateral property.
Maturity date: This is the date when all the note’s outstanding principal is due.
Prepayment Penalty: A prepayment option gives the Borrower the option to reduce their indebtedness before it is otherwise due to be paid. If a prepayment is agreed to by the Lender, it may be stipulated that the Lender must receive a minimum return on their investment before a prepayment option is available to the borrower. A prepayment penalty is a term used to denote the number of minimum interest-only payments that the Lender is to receive in addition to their principal return from the borrower.