Is your business behind on a commercial loan and unable to refinance? If so, a loan modification might be the answer. Knowing how to obtain a loan modification can be the difference between your business staying afloat or you falling into arrears. A modification, sometimes called a workout loan, can change several aspects, like making monthly payments lower or more manageable, giving you more time to pay off the loan, and reducing the amount of money you owe. Done right, a modification can get you caught up on your payments and prevent your property from being foreclosed on.
But it’s not exactly a cakewalk. For one thing, the lender has to be willing to renegotiate the loan in the first place. And the two parties then have to agree on some terms that are acceptable to both. In the case of a commercial property, it can be even more complicated.
Loan Documents
First things first: read your own loan documents. You can’t renegotiate the terms of a loan you don’t understand. In the run-up to the financial crisis, many borrowers signed loans without really understanding the covenants and conditions they were committing to. And even if you think you do know how your loan works, read it again anyway, just to refresh your memory. The devil is in the specifics.
Be very careful about whether the loan is non-recourse. If it is, that means the lender can’t come after your other assets even after it starts the foreclosure process. If your loan is non-recourse and the property won’t be worth what you still owe on it, transferring the property to the lender by deed in lieu of foreclosure might be a better idea than a loan modification.
Keeping in Touch with Your Lender
Next, talk to your lender. When payments get hard, a lot of owners try to avoid talking to their lender at all. They may miss payments, but they don’t contact the lender to explain or negotiate. Don’t do this. Lenders don’t like surprises, especially if you miss a payment or violate the terms of the loan without telling them. Picking up the phone to talk to your lender about your situation won’t solve everything. But it will give them a reason to be a lot more cooperative. In many ways, the lenders and the business owners are in the same boat. They probably don’t want you to default either.
If you are more than one month behind on payments, or you think you will be, send your lender a letter of hardship. In the letter, explain your situation and say when you expect to be able to catch the loan back up to date. Be factual. You may want to give some examples of extenuating circumstances, but don’t dwell on them. The letter gives the lender something to anchor its negotiations to. These letters are most successful if you have a history of good payments on the loan.
Lenders are much more willing to work with you than most business owners give them credit for. Lenders don’t want to foreclose on your property and take it. They’d rather let you keep working and find a way for them to get their money back. But if you’re not honest with the lender, the lender might be more likely to start the foreclosure process. In short, it is best to treat your lender like it is an ongoing business relationship.
Keeping in touch with your lender is necessary, but it is not enough to qualify for a loan modification. A lender looks at 5 things: how proactive you have been, how in the lender’s interest the equity in the property is, your loan payment history, your credit history, and your business plan (and whether the revenue projections are realistic). The lender is seeking as many points of evidence on which to base its decision to adjust the terms of the loan as it can find, and it favors a borrower who has taken the initiative. Being proactive means you reached out to the lender and made an effort to find a solution before they reached out to you. The borrower is less likely to qualify for a loan modification if there have been missed or late payments on the loan. Your wider credit record counts too.
Business plan and revenue projections are the bread and butter. The business plan is probably what the lender is looking at the most. The lender does not want to get into a modification process and then end up starting foreclosure proceedings in a few months. So the lender is looking for how you are going to be able to pay back the loan going forward. If you cannot show that your revenues are going to be sufficient to cover the business loan payments, the lender is going to have a difficult time agreeing to a loan modification. Create conservative (realistic) revenue projections. Don’t be afraid to include your realistic expenses in the plan, and do not downplay those costs or risks. In other words, no “magic fairy dust”.
Use the Expertise of a Professional
Commercial loans are generally more complicated than residential mortgage loans, so it is usually a good idea for business owners to use the expertise of a professional, such as a foreclosure defense attorney, to assist with the process. A professional will review the details of your loan documents and discuss your options with you. They will work to determine what loan terms would realistically allow you to make your payments while still running your business. They will put together documents to demonstrate to your lender that you have a plan to pay them back, draft a proposal, and negotiate with your lender on your behalf. If your lender agrees to the modifications, the professional will review the documents with you and ensure you understand your rights and obligations. The terms on the new documents should closely mirror what you agreed to with the lender, so read them carefully before signing them.
The longer you wait, the less time you have to negotiate. It’s better to get the conversation started when your cash flow starts going south, and try to get help before you default. Seek help as soon as you know you are going to have difficulty making payments, even if you haven’t missed one yet. It gives your advisor time to get everything ready before contacting the lender, and more time to find the best option for your particular situation. Remember, early action improves the chances of success.
The bottom line: Start by knowing your own loan documents, be honest with your lender, and work with a professional as early in the process as you can.
