The importance of reviewing the final loan contract.
Think of this step as checking someone else’s work. By the time you receive the “ready-to-sign” contract, its contents shouldn’t be unfamiliar to you. If you arrive at closing seeing it for the first time – well, you’ve got a problem.
While many times things will not have changed from what you’ve discussed, lenders make mistakes, move too quickly or incorrectly assume some contract elements are “standard” to their processes and don’t need discussion are when those are the sections that give you the biggest headache. (Remember how we said nothing is standard? Negotiate!)
Because of this, it’s your responsibility to prevent future headaches and protect yourself by knowing down to every dotted “I” and crossed “T” exactly what you are signing. (Or, better yet, working with an attorney. It’s what they do.)
Documenting the loan means creating the appropriate security documents and disclosures and furnishing them to you, the borrower. It is complicated and time-consuming work, especially since (we really can’t say this enough, can we) private lending is not a cookie-cutter industry. It’s very possible that each loan is different from the next, even for the lender.
Read on below for common contract elements, but first – other articles in this series:
You Should Care About Private Money Loan Process
Step 1: Find Your Lender
Steps 2 & 3: Don’t Sweat the Negotiating Table
Step 4: Don’t Sweat the Negotiating Table
Step 5: Zzz…Don’t Sleep Through Loan Contract Review
Step 6: The Closing Table
Step 7: Pay Your Debt, Darn It
Private money loan contract elements
Below we cover the main pieces in your loan contract puzzle. Still, there may be additional sections and loan clauses depending the specifics of your loan. Beyond that, you should see most of the following private money loan contract elements, although they may go by different names.
- Effective date: The date you sign the loan contract (closing), usually also when money is disbursed to you.
- Definitions: The contract should specifically identify and define all key terms.
- Parties: Who is party to the loan, usually you, the borrower, and the private lender or investor.
- Promissory note: The specific clause that spells out loan amount, promise to pay and repayment conditions; often called the terms and conditions.
- Security documents: Either the Mortgage or Trust Deed.
- Collateral: The property used to secure the loan if the borrower defaults.
- Penalties for non-payment: What happens and when if you miss your payment due date, including grace periods.
- Defaults and acceleration clause: What happens if the borrower or lender doesn’t fulfill their side of the loan, usually focusing on the borrower defaulting on payments.
- Personal guarantee: Allows the lender to pursue defined avenues to collect the debt if foreclosure doesn’t satisfy it (may not always be present).
- Governing law: Identifies which state law is applicable to the loan.
- Non-monetary covenants: Stipulations besides your scheduled payment that you must maintain for a portion or the length of to avoid defaulting.
- Representations of the borrower: Affirms that the statements and documentation you provided to qualify for the loan are true.
- Bad-boy clauses: What circumstances of you acting in bad faith that will trigger default, acceleration or other defined remedies. Most commonly this pertains to non-recourse loans.
- Amendment clauses: Specifies under what conditions the parties may amend the contract, if any.
- Arbitration clauses: How you and the lender resolve issues that come up after closing.
A note on definitions
As you’re likely aware, the above private money loan contract elements are in many ways an oversimplification of what you will see, and written in laymen’s terms where your loan contract will not be. Because of this, for your first few private loans, we cannot recommend enough that you go into the deals having budgeted and picked out an attorney.
Because here’s the thing: while private lenders are generally not predatory, and you’ll never have cause for many of the clauses to see the light of day, contracts are not for when the sun is shining and everything is fine. They are for when everything goes to hell in a handbasket. You need someone who fully understands that hell to watch your back.
Talk to a lawyer.