Although they do not have to be, in most cases, a hard money loan will need to be personally guaranteed. There are many reasons for this, the most important of which we will go over below.
The Need for Full Recourse
If a loan is business related and it is also a hard loan, it will also probably need to be a full recourse loan. As a part of this full recourse definition, the lender of hard money will likely require a personal guarantee from the borrower. When both of these conditions are met, the lender can be sure that you, the borrower, are more invested in the project. This practice is also known as “putting skin in the game,” and it is quite common among lenders and borrowers in this situation.
The full recourse loan and the guaranteed loan are distinct financial instruments. They are also defined differently from a legal standpoint. If a loan is funded by private monies, it can be either full recourse or non recourse.
The loan that is full recourse allows the lender to pursue the borrower by collecting on other assets in case of a default or a partial non payment. A borrower does have a defense against this – he or she can title assets using other names in order to guard against full recourse.
Full Recourse Without a Personal Guarantee
If a borrower invests in a full recourse loan without a personal guarantee, the borrower must protect assets under another name in order to shield those assets from lien or lawsuit. Full recourse does mean that a borrower takes full responsibility for a loan, which means that all assets that are tied to that borrower are up for grabs.
Full Recourse Without a Personal Guarantee
A borrower may also use an outside entity such as an LLC to borrow. Even if this LLC takes on a full recourse loan, the borrower is protected against any seizure or action against assets that are outside of that LLC. Because the LLC is a business entity, it cannot give a personal guarantee. It is almost as if someone else is borrowing the money.
Because of the LLC shield and other protections that borrowers may have, many lenders do not allow LLCs to borrow money. They may also require a personal guarantee, which means a borrower cannot use an LLC to borrow in the first place.
The Different Kinds of Guarantees
Not all guarantees are the same. There are many different kinds – the unlimited personal guarantee, the limited personal guarantee, and the conditional personal guarantee.
The unlimited personal guarantee means that there is no limit on the amount of money that a lender can collect in reference to a loan. If the lender has to take the borrower to court in order to receive pay back, the borrower would be responsible for the legal fees as well as the interest that would accrue. If there were any other costs that were associated with the loan, the borrower would pay those as well.
A limited personal guarantee sets an arbitrary limit on the amount of personal liability that a borrower takes on. This type of guarantee is most useful with loans that involve more than one company shareholder. However, most limited personal guarantee contracts will contain a clause that converts a limited personal guarantee into an unlimited personal guarantee in the case of fraud. This clause is also known as a “bad boy” clause.
A conditional personal guarantee is not always valid unless there is a certain trigger event that takes place. For instance, if a loan has a low loan to value metric and the borrower is not taking on a great deal of risk, the guarantee may only become valid if certain conditions are not met.
Enforcing a Guarantee
No matter what type of a guarantee is agreed to, the party in charge of enforcing it may change. A lender has the right to sell a contract to a third party at will in most cases. Just because ownership of a lending contract changes does not change the terms of the agreement.
The terms within a loan contract may be enforced with more fervor if the loan is sold to a third party that does not know the borrower, however. This is why many borrowers try to enforce a clause that the loan may not be sold.
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