What It Means for You When a Private Lender Personally Guarantees a Loan.
Physical property is one of the soundest forms of loan collateral in existence, so it’s no wonder that lending entities of all types, from megabanks like Wells Fargo to private, individual lenders, like real estate so much. As our sitting president has famously said for decades, “Real estate is always good as far as I’m concerned.” Property has inherent value and “is never worth zero.” As a result, a note created with real estate as the collateral is often a very attractive loan indeed.
However, since the housing crash, many private lenders have added a new component to the allure of real estate as collateral on a private mortgage note or private hard-money loan in order to induce more investors to loan private money. That benefit? A personal guarantee that the loan will perform.
Properly applied, a personal guarantee from a private-money lender that your investment funds, when loaned through them, will be repaid on time and at the terms you agreed to regardless of whether or not the flipper or rehabber who borrowed the money remains involved to the end, is a true advantage the party lending the money and to that borrower as well.
How a Personal Guarantee on Private Money Works
Personal guarantees can be placed at multiple points in a hard-money loan, and they are often confused with full-recourse terms. Everyone on both the borrowing and the lending sides must fully understand where and when the personal guarantee comes into play and what the terms entail.
A personal guarantee can take several forms:
Unlimited, when the real estate investor borrowing the money guarantees the entire loan amount, all legal fees, accrued interest, and costs associated with collecting on the loan even if the collateral and additional assets belonging to the borrower and unrelated to the loan must be sold in order to do so.
Limited, when there is some limit set on the amount of liability that the borrower will assume if the debt cannot be paid according to the initial terms of the loan.
Conditional, when a certain series of events “triggers” the guarantee. For example, if a borrower fails to meet certain requirements during repayment, then the lender may step in and take over the deal.
Note: Full-recourse loan terms are easily confused with personal guarantees because they essentially put many of the same assets “at risk” if a borrower fails to meet the terms of the loan. A full-recourse loan allows the lender to sue the borrower personally for loss not recovered by liquidation of the collateral. However, if the borrower is an LLC owned by an investor, then a full-recourse loan that does not have a personal guarantee only enables the lender to pursue the assets owned by the LLC to compensate for a loss, not the personal assets of the borrower.
A New Level of Teamwork
While a full-recourse loan or a personal guarantee on a loan might sound intimidating at first, many investors actually prefer to work with hard-money lenders who offer personal guarantees on their loans. The guarantee can create a team atmosphere by putting everyone involved in the loan on the same side, so to speak.
“When there is a personal guarantee involved, every investor knows that they are looking at the same due diligence that we are,” explained Rob Barney, president of DHLC Investments Inc., a hard-money lender based in Texas. “That lets them look at the transaction and say, ‘Hey, I’ve got questions, would you please address them so that I can feel more comfortable with the transaction?’ On the other side, we make sure that our borrowers are only buying properties that make sense because I don’t make loans on properties that I don’t want to own myself because my personal guarantee requires me to potentially do just that if the loan goes south.”
Barney’s personal guarantee takes the form of a commitment to “step into the borrower’s position in the event of a default and housing crash. Barney no longer had access to the commercial lines of credit he’d used for funding, so he did a capital raise with family and friends.
“When I started relying on personal capital, I made that personal guarantee,” he said. “After that initial capital raise, I decided to do it all the time for two reasons: it allows investors to have a level of confidence that they are not left on their own if a property forecloses, and it forces a higher level of underwriting on our side of the equation because I won’t loan on something I’m not comfortable with possibly having to own.”
While experienced flippers and rehabbers may not need a hard-money lender’s help and advice, having a loan from a lender who makes personal guarantees can help if you are new in real estate. Even experienced investors often rely on Barney’s second opinions because he has a vested interest in helping them turn a profit. “I want the borrower to sell the house, make a nice chunk of change, and pay my investor (and me) back according to the terms of their loan,” said Barney. “Then, I want them to come back and do it again!”
A personal guarantee clause from a hard-money lender can mean you have a good, experienced source of information quite literally waiting on your call.