As traditional mortgage lenders tighten their belts, more business-purpose borrowers are looking to private sources to get the funding they need. It’s a great time to be in the private lending industry because when a loan is done right, there’s a lot of money to be made. When done incorrectly, however, you’re only one bad deal from being out of business.
State law is one area where it’s easy for mortgage brokers and lenders to go awry without even realizing it. The changing legal landscape from state to state can drastically reshape how a lender handles a deal just by its location. To understand how the law impacts a client’s loan transaction, it’s important to understand what changes have taken place, why the changes were made and how being unaware of them can endanger a deal.
Legal landscape
While there are numerous ways state law can apply to a transaction between a commercial lender and a borrower, there are some key areas that borrowers should discuss with their chosen lender. Brokers should make clients aware of this information because it can potentially impact the transaction at hand.
Some states require commercial mortgage brokers to have a license before lending on properties within their borders. In California and Arizona, for example, a broker must have a state license, whereas they do not need to acquire one in New Jersey and New York in many circumstances.
Licensing requirements can vary depending on where the lender falls in the transaction. Whether or not you can be a direct lender, table funder, correspondent lender or white label lender (or whether you can make a secondary market sale or purchase) depends on a detailed review of each state’s law. It’s vital to check with the proper authorities and your legal counsel before conducting business in a new state.
Fees and penalties
The maximum interest rate that can be charged — defined and governed by usury laws — differs from state to state. Depending on where you’re trying to close a loan, several types of fees can add up and count toward this cap, including origination fees and legal expenses. No two states are precisely the same in this regard, so be sure to proceed carefully.
There are late-fee payment restrictions in most states. The circumstances for when a borrower will be charged late fees and how much those fees can be are governed by state law. Business-purpose borrowers also may be subject to several types of prepayment penalties, including fixed prepayment penalties and yield maintenance prepayment penalties. Again, whether a borrower can be charged a prepayment penalty differs from state to state.
Of utmost importance to lenders is their ability to recover the collateral in the event that the borrower is unable to repay. Ensuring the correct legal language covers this issue in the event of foreclosure is vital before all parties sign on the dotted line. If a lender doesn’t have the right language in their loan documents, this could mean that they’ll be unable to foreclose and further legal action will need to be taken.
Federal laws
It is important for commercial mortgage brokers to be aware of how federal laws may impact private lenders. There’s a false sense of complacency when it comes to federal law, as many private lenders that serve commercial borrowers may think these statutes only apply to residential (consumer-purpose) real estate transactions.
That’s simply not true. A whole body of federal regulations, obligations and criteria can impact how a private lender can operate in the commercial real estate space. One example includes the Home Mortgage Disclosure Act, or HMDA, which requires lenders and federal agencies to collect data designed to prevent discriminatory lending practices. Although the law has “home” in its name, private commercial lenders also are privy to some of its stipulations.
When it comes to usury laws, aside from the state statutes that affect these fees, federal law also impacts how much the borrower can pay and when. Allowable rates are shaped by the size of the loan, the purpose of the loan and the creditor type.
Impacting business
Commercial mortgage professionals focus on originating, brokering and closing deals. But they also should remain aware of changes to the law and how these shifts may impact their work. To help manage this process, an attorney with expertise in private lending law can be a tremendous asset. That’s due to two major reasons: the complicated nature of the laws and the speed at which laws can change.
It’s not just about which laws change or when they change, but if and how they impact your business. Not every regulation will apply to every deal type, and there are intricacies to consider that can ultimately make or break a transaction.
Although it’s the responsibility of all parties to abide by the law, they are not expected to fully understand the applications and exemptions to each of these statutes. That’s why private lender law is its own practice. Experts in this field analyze every change to commercial real estate lending laws in every state, so they are at the ready to advise on recent changes and ones coming up the pike.
Changing regulatory scene
Many laws are created, passed and enacted in reaction to current events. Just like news is ever-evolving, a regulatory body’s response to current events can be swift and sudden.
The COVID-19 pandemic is an excellent example of this phenomenon. As businesses shuttered under government mandates and customers stayed home, many revenue sources dried up seemingly overnight. Some commercial real estate owners found themselves unable to keep up with mortgage payments, leaving lenders in the lurch.
Many states, including New York and New Jersey, suspended foreclosure actions in 2020 that directly impacted how private lenders could (or more accurately, could not) recoup their losses. This left lenders in an even more stressed position as they ran out of ways to get their money back.
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Before you enter into a commercial mortgage agreement in any state, it’s important that you proceed with caution. Prior to making any move to expand your commercial lending or brokerage business, calculate the risks and benefits. At the end of the day, the only risk a lender or broker should take is market risk. Gambling with the law can result in costly legal mistakes and potentially jeopardize the deal at hand — or even your business.
The commercial mortgage industry carries a lot of risk. With risk comes opportunity and reward. The smartest and most successful lenders and brokers continue to check the law for changes that affect their business, and they adhere to best practices for how they operate. ●
