7 Ways to Spot Bad Lenders—Beware
When it comes to commercial real estate finance, working with the right lender is crucial to the success of your deal. However, not all lenders are created equal and it's important to know how to spot a bad lender before you get too deep into a transaction.
Two years ago, a client (let’s call him Jim), signed a term sheet with a lender to develop a small hotel. However, before closing the loan, the lender suddenly changed the terms of the agreement by increasing the interest rate without warning. Understandably, Jim was angry and confused. When he confronted the lender, they said the changes “were necessary to protect the investment and were standard policy for all loans.” Jim felt cheated and decided to call StackSource to seek professional help. Luckily, StackSource had a longstanding relationship with the lender and was able to convince them to honor their original terms.
Not all commercial real estate sponsors are like Jim. Especially if it is one of your first deals, you might think it is reasonable to defer to lenders or be afraid to look for another after you have agreed to terms. It is crucial to know how to spot a bad lender like in Jim’s story before you get too deep into a transaction.
Here are seven red flags to look out for:
1. Wolf in Sheep’s Clothing
This is a person or company that may misrepresent themselves as a lender, but, in reality, they are a broker. The difference between a lender and broker is clear – a lender will provide the funds while a broker connects a sponsor to a lender. However, we have seen instances where a broker will pretend to be a lender by offering loans and setting terms. Instead, they are actually working to secure the loan from a different lender and giving themselves a commission. This can result in higher costs for the borrower as the broker will add fees on top of the lender’s fees.
Brokers are helpful, but they should clearly represent their role and intentions. In order to avoid this, borrowers should thoroughly research any lender or broker they are working with and ensure transparency about any fees or commissions.
This is exactly what happened in Jim’s story. Re-trading is when a lender changes the terms of the deal without cause. There are various ways to be re-traded including: increased interest rate, lower leverage, requiring recourse when originally there was none required, etc.
In this situation, you would first try to talk to the lender and review the term sheet to see if there is a reasonable cause for the lender to change their terms. If there is no such reasonable cause and you believe the lender has acted unfairly, you can seek advice from our professionals at StackSource. You can also consider refinancing the loan with a different lender to avoid continuing the financing relationship.
3. Killing Term-Sheeted Deals
This is a lender that kills a deal without any good reason. One example we have seen is when the lender’s team overlooks something originally disclosed and decides to kill the deal. Another example is when the lender changes their program mid-deal, decides the deal no longer fits within their parameters, and then kills it. We have even seen lenders delay a deal for months with assurances that the loan would be approved only to kill it without a good reason later.
Note that there can be cases where this is permissible such as additional information uncovered that substantially changes the risk-profile of the deal.
4. Lack of Professionalism / Poor Work Flow Processes
This includes lenders that are unreasonable, temperamental, nasty, and hostile. This also includes lenders who are unresponsive or who do not take ownership of their mistakes for why a deal is delayed. Less obviously, this can mean lenders who put borrowers under an arduous and slow loan process.
Sponsors must understand that this is abnormal, and such behavior should not be condoned.
5. Fake Term Sheets
Another red flag to look out for is a lender who provides a term sheet and collects an initial deposit from a client even though the lender knows they can’t close the deal. This is highly dishonest. These nefarious activities are in an effort to collect money upfront from the initial deposits with the intention of not returning any money or only returning a small portion.
6. Unnecessarily Unreasonable
We have had a situation where a lender picks a specific appraiser without any input from the sponsor. The lender refused to explain why they chose that appraiser and would not allow for a competitive bid process for the appraisal report.
Another lender made it on our ban list because he contacted our borrower directly and scared the borrower into acting without consulting us first. The lender threatened that he would not move forward if the wire was not sent immediately.
Here, it is important to remember that borrowers have rights. If a lender is being unnecessarily unreasonable, this is a red flag that a borrower must consider.
7. Too New
The last red flag we have identified are companies that are too new or if they have a new process or program. This does not mean that they are bad lenders, but more so that additional caution is needed. For StackSource clients, we advise them to tread cautiously and ask more questions (especially getting referrals) because the risk is too high to be their guinea pig.
Overall, be sure to do your due diligence and comprehensively research the lender before entering into a transaction. Check online reviews, ask for references, and make sure that the lender has a good reputation in the industry. Remember that a good lender will be transparent, communicative, and have a good reputation in the industry. Finally, like in Jim’s story, do not be afraid to be resourceful and seek professional guidance.
Good luck out there my friends.
I’m happy to engage with you in the comments so that everyone can learn. If you prefer to share privately, feel free to email me at firstname.lastname@example.org. This blog piece was written with StackSource colleague, Avery Ngo.
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