You may be worried that the government will take your house away. If you signed an unconditional personal guaranty on an SBA loan and pledged your home as collateral, which is standard practice for SBA lenders in many states, then yes: if the business defaults, the lender can exercise their right to pursue your personal assets to satisfy the debt. Your home could be foreclosed on. It sounds simple, right? But a lot happens in the period between the business stopping payments, and the bank foreclosing and SBA going after the house.
The SBA does not always urge its lender to foreclose, even when both of them have the legal right to. In other words, having the right to take your home doesn’t mean the lenders do it. The SBA lender generally needs and wants foreclosure to be financially worthwhile. A few factors go into that decision.
First in Time, First in Right
The first is whether you have a first mortgage on the house that sits ahead of the SBA loan. If you do, that may help you. Property law generally ranks liens in the order they were filed in the county records office, a rule known as “first in time, first in right.” Put simply, the lien that is recorded first has the right to be paid first. So whoever filed the first lien will get his or her share first out of the proceeds of the sale. This means that the SBA lender is lower than a first mortgage in the pecking order of priority.
When a house is sold at foreclosure, the money goes first to repay the first mortgage in full, along with the costs of the foreclosure. The first mortgage holder gets paid before the SBA lender, so the cost of foreclosure may or may not leave the SBA lender anything. If it doesn’t, the lender likely won’t go after the home. They need to make sure their lien is worth the foreclosure cost. When there is an intervening first mortgage that decreases your home equity, the SBA lender’s hands may be tied.
If your equity is zero or very low, the SBA lender may choose to do nothing for now. They “wait and see” to see whether there’s anything left to collect. The lender may sit on its lien, hoping the value of the house will go up. Once it recovers enough value so they’ll get something when they get around to it, the SBA lender may move and finally exercise the legal right to foreclose. In many cases a foreclosure is not started for years, and then only if your home has gone up substantially in value and something has brought it to the attention of the SBA lender or the SBA.
Home Equity
Home equity is the difference between what your home is worth and how much you owe on it. If you owe more on your home than your home is worth, then you don’t have equity; if the value of your home exceeds the amount you owe on it, you have equity. A second mortgage, home equity loan or credit line, tax liens, etc., will count against your equity and reduce it. As you borrow more against it, your equity shrinks.
Say your home is worth $225,000 and you owe $100,000 on a first mortgage. That leaves $125,000 of equity, and in an SBA default that might tempt the SBA lender or the SBA to foreclose. Now add a second mortgage of $75,000. Your equity drops to $50,000, and the SBA lender is in third position. After the first mortgage is paid, the second mortgage is paid, then finally, the SBA lender gets paid. How will the SBA lender react? Will they urge foreclosure? (Well, at least not before they do a little due diligence, right?) In this example, remember the lien ordering rule? First in time, first in right. This means the SBA lender would not see that much equity on which to tip their hat, and they might elect not to take any action at all. Review all of your mortgage debt with your attorney if you are weighing what an SBA default would mean for you.
Release of the Lien
Can you make the SBA lender an offer to release your home? Yes. You can make an offer in compromise to settle your total liability under the personal guaranty, or you can make an offer just for the release of the lien on your home. It makes sense that you wouldn’t want to pay full value just to get the house out of jeopardy. But be careful. If you only buy the release of the lien, the problem is that the SBA lender still has your personal liability. You might pay the release of the lien amount and have to pay back the personal guaranty portion of the debt. You need to be vigilant about where and when in the process the release of the lien should be executed to make sure you’re covered. Otherwise, you might pay the SBA for the release and they move to recover on the personal guaranty later. If the lender wins a judgment and places a judgment lien on your real property, it can potentially apply that judgment to your house, too, leaving you worse off than you started.
Handling the release correctly may require professional help. It should be part of your exit strategy. In many cases the release of the lien on your home can be combined into a complete offer in compromise settlement package. Many variables can affect the outcome, so it’s important to be sure you’re getting the right advice. You want to ensure you’re not making a move that may turn around to bite you down the road.
So before you decide you’re going to lose your house, wait until you get all the cards on the table. Because although the lender or the SBA may have the right, they may not take that right. Do a realistic assessment of your net equity to determine how attractive the foreclosure option is to the bank. Your own equity, as compared to the priority of the SBA bank lien, will heavily influence the timing and likelihood of a foreclosure. Talk through your goals completely, and make sure you meet with your attorney or CPA before signing anything.
