If you start a business and fail to pay its debts, can the federal government, specifically the Small Business Administration, seize your personal property, including your house, to collect? As you know, when you start a business, you create a separate legal entity to operate it. The reason you take this step is to protect your personal property from the claims of your business’s creditors. However, here’s the thing: when a bank makes your business an SBA loan, what does it require in exchange?
Although every case is different and will depend on your specific circumstances, the short answer to whether the SBA can take your house is yes. When you apply for an SBA loan, the bank will ask you to sign an unconditional personal guaranty, which is essentially a promise to pay the loan personally, regardless of the business’s financial condition. But that’s not all, the bank will likely also ask you to pledge your home as collateral for the loan. In many states that is standard practice. If the business defaults, then the lender can foreclose on your house and sell it to recover the outstanding debt. They don’t necessarily have to do it now, but they have the right to. Most business owners don’t realize the danger in mortgaging their home. What they don’t know can hurt them.
A legal right to foreclose, however, is not the same as a decision to foreclose. The SBA does not always push the lender to go after the house, even when there is clear legal entitlement to do so. Ultimately, the decision of whether to foreclose on your house or not will depend on a variety of factors, including the specific circumstances of the case and the discretion of the SBA. It really is a numbers game.
First in Time, First in Right
But there are other things that they need to consider before they will actually go after your house. For example: They will have to check for any liens that were recorded before their lien was recorded. The general rule in property law is that the order of liens is determined by the date of recording of the liens. Lawyers call it “first in time, first in right.” For example, if you own a home and place a first mortgage lien with Mortgage Company “A” and you then later record a second mortgage lien with Mortgage Company “B” and the title is recorded with mortgage “A” as the first lien and mortgage “B” as the second lien, when the property is sold, Mortgage Company “A” gets the first payout and Mortgage Company “B” gets the next payout.
That is why a first mortgage on your home that was recorded ahead of the SBA loan can actually help you. So if you recorded your mortgage with the county recorder’s office before the SBA took a lien position, they would have to pay off the first mortgage holder first before they would receive any proceeds from a foreclosure. The cost of the foreclosure itself is also removed from the amount the SBA would receive. All of that makes foreclosure less attractive to the SBA lender, and if there are other people ahead of the SBA, you are more protected.
Amount of Equity Left in the Home
Another consideration is the amount of equity left in the home. If there is little to no equity, it may not be worth their effort to collect. They can do nothing, and simply wait for the property to go up in value enough to be able to foreclose on. They would rather wait until your property appreciates to a higher amount. This way, they can recover more money. The SBA lender can sit on a delinquent debt for years. In many cases a foreclosure is not started for years, and then only if the house has gone up substantially in value and something has brought that to the attention of the lender or the SBA.
So what is equity? It is the fair market value of your home minus the balance of every lien recorded against it. Think of equity as the portion of your home that you actually own outright. Say your house is worth $225,000 and you owe $100,000 on a first mortgage. This would mean you have a theoretical $125,000 in equity, which equals your current market value minus total liens. In an SBA default, that much equity might tempt the SBA lender or the SBA to foreclose.
Now, what happens if your property also had a second lien, a $75,000 second mortgage? Your equity drops to $50,000, and the SBA lender is now third in line, behind both mortgages. Do you think the SBA lender is going to foreclose? So in the second scenario, it is much less likely the SBA would foreclose on your home. If you are dealing with an SBA default, go over all of your mortgage debt with your attorney.
Offer in Compromise
Can you make the SBA lender an offer to release your home? Yes, through an Offer in Compromise. You can use the offer to settle your entire debt or offer to pay the SBA only to get the lien on your house released. Be careful with the second one. If you do decide to settle with the SBA lender only to have a lien released on your house and not to settle your debt, the debt is still there and the lender may put a new lien on the house at any time in the future. It can sue you on the guaranty, win a judgment, and record a judgment lien against your real estate. Then you’re in the same place. If your idea is to release the lien on the house with a small offer, don’t expect it to be a good idea. But if you plan to settle your personal guaranty with the SBA, then it may be a good idea.
So my advice is to have a professional negotiate the release of the SBA’s lien in your home. It should be treated as one part of your overall strategy, not a separate project. In many cases the release of the lien can be combined into a complete offer in compromise settlement package. There are so many variables in each individual case that it’s hard to generalize. Be clear about your goals, and it would be wise to talk it over with your CPA and your attorney.
So, can the SBA take your house? The short answer is still yes. But whether they actually get your house or not depends on a number of factors: what is recorded ahead of them, how much equity there is, and what you do about it. If you feel your house is at risk, get professional help before you make any offer.
