Originally published in Northbay Business Journal, June 13, 2009.
It's common knowledge that the financial markets, and the entire banking industry has been in a state of upheaval and turbulence. Regulatory forces are "circling this wagon" with ardent zeal to try to restore some kind of order to this lending environment chaos.
One area that appears to have slipped through the cracks is the world of pre-payment penalties for commercial loans. I ran into a situation recently that I think bears thorough examination and scrutiny.
Currently; the law specifies that a prepayment penalty for a commercial loan may be considered "onerous" if it "Shocks the Conscious of the Community".
I wonder what that means. You be the Judge of a current situation...
I have a client who had a $450,000 note against a Small Apartment Complex that had a valuation of approximately $1,100,000.The note had originated approximately one and a half years ago, and the client needed to sell the complex for health reasons.
When the escrow was about to close; she was informed by the lender that her prepayment penalty was over $220,000... almost a 50% penalty. My client had no idea that kind of onerous penalty was a condition of that loan.
When she asked the original Loan Broker about this penalty; he insisted it was a mistake. As it turns out IT WASN'T a mistake, but the fall-out of a deceptive murky "lock-out" clause that allowed the lender to re-coup all the interest in that loan had it come to full maturity. This was way beyond a yield maintenance issue.
My client was under the impression that the prepayment penalty was approximately 5% of the balance of the Loan at the time of the pay-off, and did not understand the terms and conditions contained in a "lock-out" clause. Obviously neither did the loan broker.
There appear to be plenty of rules and regulations that govern single family home lending, but little oversight for loans that impact 4 Units and more, and commercial lending industry.
It is incumbent upon all investors/owners to make sure that they understand all the clauses contained in a new loan, and not rely on the word of the loan officer.
In the case I've outlined above; there was a discrepancy/omission in the actual document between the loan summary abstract, and the interest re-cap/lock-out clause. I would urge anyone in the market for new financing to be extremely prudent in making sure they understand the terms and conditions of that loan, and to take extreme precautions to digest ALL the implications of paying off the note early.
Candidly, I believe there should be the same/similar protections for commercial borrowers as there are for residential borrowers, and murky confusing lending documents should at least be consistent and clear so the average owner/borrower has a chance to understand the depth of the obligations they are assuming.
Does a prepayment penalty of $220,000 on a $450,000 note shock the conscious of our community? Let me know your thoughts? It's hard to stand by and watch someone so thoroughly taken advantage of.