For commercial real-estate borrowers, today more than ever before, lenders are able and willing to assist borrowers in modifying their commercial loans. With a commercial mortgage modification, borrowers that qualify can negotiate with their lenders to reduce their interest rate, extend interest-only payments for a fixed period, extend the term of their loan, and defer past due balances.
WHY LENDERS ARE WILLING TO MODIFY COMMERCIAL MORTGAGES
Modification of commercial loans is vital simply because the majority of commercial mortgages in the United States will have balloon payments that borrowers are unable to satisfy. It is customary for the borrower to refinance when the balloon payment becomes due. However, since properties are underwater-meaning they are not worth as much as what is owed on them-and financial institutions are not lending money, borrowers are faced with paying this balloon payment, or go into default, since they cannot refinance.
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Commercial mortgage modifications are going to become more common because of lenders' reluctance to foreclose on properties and from government incentives to keep commercial borrowers in their properties. For instance, the Federal Reserve established a new policy incentivizing financial institutions to take prudent steps in modifying loans, and those institutions that do will not be looked upon adversely by the regulators. In addition, the Internal Revenue Service significantly relaxed the previous restrictions on modifications for certain types of loans held by real estate mortgage investment conduits (REMICs). This means borrowers do not need to be in default in order to receive a modification, and this change fosters a smoother, lower-risk transition for all parties involved. This means a modification can occur even if a hardship is in the future, such as a balloon payment coming due a year from the date the borrower applies for a modification. This is a boon to borrowers: no longer do they have to go into default, ruin their credit, and risk foreclosure just to get a modification.
APPLYING FOR A COMMERCIAL MORTGAGE MODIFICATION
Before borrowers inform their lender that they need a modification, the borrower's loan documents need to be reviewed. If the borrower is working with an attorney, the attorney will identify all of the possible defaults in the documents. For example, failure to pay property taxes or insurance, or if the loan-to-value ratio is above an acceptable ratio, could result in a default. What could also result in a default is enforcement action by third party creditors; including liens, stop notices and mechanics liens.
An attorney will look for loopholes, which are mistakes in the borrower's favor. An attorney will also look for carve outs, which are conditions that may permit recourse against the borrowers on a normally nonrecourse loan.
PRE-NEGOTIATION LETTER
A pre-negotiation letter is the first thing the lender will need a borrower to sign. This is a letter that allows them to negotiate with borrowers for a modification. During the negotiation, nothing said is admissible in any later lawsuits. Also, nothing discussed or proposed is a binding agreement unless and until there's a written and signed final definitive agreement.
During this stage, the lender can ask the borrower to acknowledge amounts due with no defenses, or offsets. Having an attorney that understands what is being required in order to modify the loan is crucial. At this stage a borrower could unwittingly give away their legal rights and remedies.
SUPPLYING OF DOCUMENTS
The documents borrowers supply their lender for a modification is similar to what borrowers supplied with the original loan application. Borrowers will provide their lender with tax and income information so their lender can determine if they qualify for new terms on their existing loan. The necessary documents usually consist of tax returns, profit and loss schedules, and proof of accounts receivable. If a borrower is a landlord, the lender may require borrowers to provide information about of the existing leases and those tenants' respective payment histories.
TYPES OF MODIFICATIONS
There are different types of modifications. For example, a forbearance is a temporary situation, where a modification is for a longer period of time or permanent.
NEGOTIATION OF THE TERMS OF THE NEW LOAN
The final stage of the process is negotiating the terms of the commercial mortgage modification. This involves some give and take, in which, for example, the lender sets a new loan duration, interest rate, balloon amount, or other concessions in order for the borrower to avoid default on their mortgage, which could lead to foreclosure.
The lender will inquire about how long a modification would be needed and decide the new terms of the modification. The lender can also require an immediate pay down of the principal if the loan to value is too low. It is important to show the lender why they should modify the loan but also why the borrowers is in a position to pay. An attorney can help make the borrower the best candidate for a modification.
MAKE SURE THE MODIFICATION IS PROPERLY EXECUTED
Any arrangement on behalf of a borrower with a financial institution must be in writing with proper approvals. With the current market, it is unknown if the financial institution the borrower modifies their loan with will be around the following year. If the institution is having financial difficulties, the FDIC can take over the institution. If this occurs, no unrecorded agreement or arrangement between a failed institution and borrower may be asserted by the borrower against the FDIC, unless certain things occur. Thus, a year from now the borrower could still lose their property. Working with an attorney that properly prepares the modification in writing, and ensures the modification has the proper approvals is crucial since banks are failing daily.
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