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Private Lending Documents

An investor, maybe you, wants to lend some money to a real estate investor. What kind of documents are required for this transaction? The answer depends on the complexity of the transaction, but lending professionals tend to use similar documents across the board for a standard transaction.

We will start with the most important documents and go from there.

The promissory note.

This document is the most important to a loan transaction — it is the document that represents the debt. It is a unilateral written promise by the borrower to pay the lender a certain amount of money over time.

A promissory note must specify who the lender is, the principal balance of the loan, the method of payment (single payment, monthly payments, payable on demand), and the interest rate.

The terms can vary widely — fixed or variable interest, single or monthly payments — but the general rule for promissory notes is that anyone must be able to determine how much is owed at any given time by the borrower. Avoid creating conditional promises at all costs.

The reason for this is to keep the note negotiable, which means that it functions like a personal check and can be endorsed or assigned to any other lender. That means that you can sell the note to another party and they can step into the lender’s shoes without issue. If the note is negotiable, the Uniform Commercial Code applies, which is a deep set of laws with which the courts are familiar. If the note is not negotiable, then regular contract law applies, and the note would not be saleable without consent.

Here are some examples.

Good example: “I promise to pay Lender $1,000 on January 1, 1972.”

Bad example: “If the home doesn’t sell before January 1, 1972, I promise to pay the property taxes for 1972.”

Here, we can’t know what the property taxes will be or whether the house will sell, so the note is not well written.

Good example: “I promise to pay the lender interest on the unpaid principal based on the Wall Street Journal prime rate published on the first day of each month.”

Bad example: “If I do not pay by January 1, 1972, I agree that the house will be sold and the proceeds will be used to settle the debt.”

Here, this promise is not an unconditional promise to pay but instead a promise to pay whatever the house sells for.

The best way to write a promissory note is to use what we’re used to–fixed monthly payments, a fixed interest rate and a definite term.

The mortgage

The mortgage (called a “deed of trust” in some states) is a document recorded in the public records office that makes the debt become a lien on the property being mortgaged. It allows the lender to foreclose on the property and have it sold to satisfy the debt. Without the mortgage, the lender’s only recourse is to take the debtor to court and get a court order to have the borrower pay — which they can ignore.

Although it is possible to merge the mortgage and the promissory note into one document, it is usually not advisable because it will destroy negotiability as discussed above. This is because a mortgage contains many promises that relate to the upkeep of the property, like:

  • paying property taxes
  • maintaining insurance coverage
  • not selling the property without paying the loan
  • maintaining the property

Most mortgages and notes contain “cross-default” provisions, so that if the borrower defaults on the terms of the mortgage (for example, by selling the house without paying the mortgage), then the promissory note automatically defaults. This is an important exception to the negotiability doctrine discussed above, but it must be carefully written in both documents.

The assignment of rents

This is sometimes contained in the same document as the mortgage, but most commercial lenders use a separate document that is recorded after the mortgage. This document allows the lender to take over management of the property after the borrower defaults without requiring the lender to foreclose (most often by asking the court to appoint a receiver, who is usually a real estate broker who collects the rents and gives them to the lender).

The personal guaranty

If the borrower is an entity like a corporation or LLC, the individual borrower should sign a personal guaranty of the LLC’s promise to pay the debt. This is extremely common in commercial loan transactions and a necessity for almost all of our clients.

Conclusion

There are many other documents that can be seen in commercial transactions, but these are the core documents. Commercial lending is a complex process with many moving parts — don’t wait until your borrower defaults to find out that your documents were faulty. We can handle your transaction end-to-end after you and your borrower agree on terms — we draft the document package, coordinate with the title company to ensure that title insurance will be issued, and ensure all the documents are properly executed. All you have to do is send the money when we give you the green light. We do this for a reasonable flat fee — contact us today to get set up.

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