In many states, it is standard practice for an SBA lender to ask a loan guarantor to pledge their home as collateral in connection with their unconditional guaranty. If the business loan you guarantee goes into default, your homestead could be at risk of foreclosure. However, the SBA may not always urge a lender to foreclosure on your home, even if the SBA and the SBA Lender have a legal right to do so. Here are a few factors that may impact this decision:
Do you have a first mortgage on your home ahead of the SBA loan? This may help you.
The general rule in property law is that liens have priority in the order that they are filed in the county records office. This is known as the first in time, first in right rule. Based on this principle, a recorded interest has priority over later recorded interests. If your first mortgage is ahead of the SBA loan, it will make foreclosure less attractive to the SBA Lender since foreclosure proceeds must first be applied to payoff the first mortgage entirely, plus the costs of foreclosure before the second mortgage holder receives anything.
If your home equity is zero or very low, it may be that the SBA lender will choose to do nothing for now and wait hoping the home will increase in value over time. In many cases, if this occurs, a foreclosure may not be initiated for years and then only if the value of your home has substantially increased and some factor has brought this to the attention of your SBA Lender or the SBA.
What is Home Equity?
Home equity is the market value of a homeowner’s unencumbered interest in their real property, that is, the difference between the home’s fair market value and the outstanding balance of all liens on the property. For example, if your home is worth $225,000 and you have a first mortgage to Bank X for $100,000, then you have $125,000 of “Equity” in your property and, in an SBA default situation, that might tempt the SBA Lender or the SBA to foreclose. However, if you add a second mortgage of $75,000, then you only have $50,000 of equity in your property and, in a foreclosure setting, this may not be enough for the SBA Lender (in a third position behind your second mortgage) to foreclose. Be sure to review all your mortgage debt with your attorney if you are discussing the consequences of an SBA loan default.
Can I make the SBA or the SBA Lender an Offer to Release My Home as Collateral?
Yes, you can make the SBA Lender an Offer in Compromise to settle your total liability associated with your personal guaranty or you can just make an offer for the release of the lien on your home. But, use caution. If you obtain a release of SBA Lender’s lien on your home without also completely settling your liability under your personal guaranty, you might later be sued by the SBA Lender. If the SBA Lender obtains a judgment, and then places a judgment lien on you real property, your home may be at risk all over again.
Handling the release of an SBA lien on your home correctly may require professional assistance. It is important to consider this action as a part of your overall strategy. In many cases, it may be possible to combine the release of the lien on your home as part of your complete offer in compromise settlement package. But, many variables can affect the outcome, so be sure to discuss your goals completely with your attorney and/or CPA.
In general, you will need permission to sell your home if the SBA lender placed a lien when you took out your SBA loan. There are many circumstances under which you may need to sell a home with an SBA lien on it. Here are a few:
I am changing jobs and must move out of state and buy another home.
If you are not in default of your SBA loan, then you should talk to your SBA Lender about “Substitution of Collateral” and “Replacement Liens”. In certain circumstances, the SBA Lender may be willing to allow you to essentially swap collateral if, in doing so, its rights are not adversely affected. In some cases, the replacement property may, in fact, have more equity making the arrangement even more attractive to the SBA Lender.
Another common scenario is the need to sell a rental property which is simply not making money and provide the SBA Lender with a lien on another property you own that was not previously pledged as collateral. Again, if this arrangement will not adversely affect the SBA Lender, they may allow you to do so and thereby permit you to liquidate non-performing investment property in order to use the capital more effectively elsewhere.
I will lose my house to foreclosure if I don’t sell it, but there is not enough money to pay off my mortgage and the SBA.
Under certain circumstances, the SBA Lender may be willing to accept a short sale if not doing so would likely result in a worse recovery or perhaps no recovery at all. If you are in this position, be sure you determine what it will take to payoff all tax liens and prior mortgages on your home, then approach the SBA Lender with the best offer you can obtain for the property and an appraisal of the property. In many cases, if the deal makes economic sense, the SBA and the SBA Lender will agree to it.
What is a CDC/504 Loan?
The Small Business Administration (SBA) has a loan program know as the “504 program”. The 504 program helps small business owners purchase commercial real estate (e.g., a hotel/franchise or a small office building). Unlike the 7(a) program that incentivizes private lenders to help small business by partially guaranteeing their loans, the 504 program is a hybrid.
Under the 504 program, the the borrower has two loans: one to a private lender and another to a Certified Development Company (CDC). In such scenarios, the real estate is financed by a conventional loan that is not guaranteed by the SBA; this lender covers 50% of the project. The second player is the CDC, a nonprofit company acting as a conduit for SBA funds, and it funds 40% of the project; this loan is 100% guaranteed by the SBA. The remaining 10% of the project is funded by the borrower.
In a CDC/504 Loan, the private lender takes a first position lien on the real estate while the CDC takes the second position lien. In the event of a default, a short-sale or foreclosure will usually result in proceeds sufficient to pay off all or nearly all the private lender. I say “usually” because as some of my colleagues have pointed out, real estate in some markets has taken a nose dive.
I am current with the bank, but months behind with the CDC, why aren’t they foreclosing?
The short answer to the question is that your first lender is not in monetary default, so they are unlikely to foreclose on the basis that you have defaulted another obligation, although in some cases breaching loan covenants and representations and warranties will stir a bank to action.If the second lien holder files a foreclosure action, the sales proceeds must still be applied in order of lien priority. Therefore, if the CDC sees that it will not reap enough to make foreclosure worth it, then why foreclose at all. In many cities market conditions for certain types of commercial real estate are so bad that the CDC simply cannot foreclosure. This posture is then assumed by the SBA once the guarantee to the CDC is paid and the SBA assumes actual ownership of the Note and Security Agreement plus the attendant personal guarantees.
If the SBA won’t foreclose, why do I need to worry?
Although foreclosure may not be in the cards for you, that is not to say the CDC won’t sue the borrower and/or pursue the guarantors. And, if they choose not to do so, the SBA still can once the guarantee payment to the CDC has been made. An SBA Offer in Compromise (OIC) may be an available option. If initiated early an OIC can sometimes provide hapless guarantors an opportunity to walk away from a mountain of debt for a relatively modest percentage of what was owed. But, a settlement is not foregone conclusion. The SBA will expect you to dig deep and make a serious offer, otherwise a quick rejection often follows.
Remember, if the SBA cannot collect, then they will send the bad debt to the Treasury Department for collection where a 28% one-time collection fee will be added to the debt. In addition the Treasury Offset Program (TOP) will begin to review the file and take action, including tax refund intercept and offset of social security benefits if you are already receiving them. And, if that is not enough, and you are gainfully employed, you will likely be the recipient of a federal wage garnishment order that can remain in effect continuously until the debt is paid in full.