Careful Lending

Table Of Contents

Glossary

Borrower/Mortgagor/Grantor of Charge

The person who receives the money for the loan and who has to pay it back.

Lender/Mortgagee/Security Holder/Grantee of security interest

The person who provides the money initially for the loan and who needs to be repaid.

Guarantor

Someone, in addition to the Borrower, who promises the Lender that the Borrower will meet the Borrower’s obligations.

Guarantee

The promises a Guarantor gives to the Lender.

Security

The extra rights a Lender has to force recovery of the loan beyond the obligation of the Borrower and the right to sue the Borrower.  For instance, the security might be the guarantee by someone other than the Borrower but if the Borrower doesn’t pay, the third person will.

The most common form of security is a mortgage over property so that the Lender can sell the property to claim back the loan.

Mortgage

A claim over property, or the document creating that claim, which gives a lender a right to take action directly against the property .  Possible actions might include forcing sale of the property or taking control of the property.

Charge

A claim over property, or the document creating that claim, which gives a Lender a right to prevent the Borrower taking action with the property without answering to the debt.

Caveat

A warning note on a title that limits dealings with the property contrary to a claimed interest.

Should I be a lender?

Lending needs care.

If you are lending like a bank, think like a bank.

What happens if the lender does not pay?

Carefully assess the borrower’s financial position, the extent of security for the loan and the general economics of the loan.

Assess not only the borrower’s means to answer your loan but your needs for the loan to be repaid.

Is the agreed timetable for repayment satisfactory?  Will you be able to cope if that timetable is not met?

Banks spread the risk of failure to pay across many loans.

Can you afford to rely on your loan?

Your lawyer is not in a position to assess such financial matters.  You may need to take independent financial advice.

What are the Key Issues?

The key issues on a loan are:

  • the amount of the loan;
  • what interest is payable, if any;
  • when is the interest payable, monthly, quarterly, or at the end of the loan;
  • when is the capital repaid? Is it repaid as a lump sum at the end of the loan or by instalments;
  • what happens if the borrower doesn’t pay as agreed; and
  • will you be repaid?

What if the borrower does not pay?

Like any other agreement, if someone breaks a loan agreement the other party can take court proceedings to enforce the agreement.  If proceedings are successful, the court can enforce a judgment against the person responsible, or their assets.

Often lenders are not satisfied with court proceedings to recover loans.  Often lenders want to have the loans secured directly against assets.

If the loan is secured, the lender has special claims to enforce the debt.

Do you need the safety of assets available to secure the loan?

A lender is in a stronger position and it is easier to enforce the loan if they can take action directly against property.

Consider carefully what security you need.

It is no surprise that banks usually insist on having a loan secured.

What sort of security is available?

There are many different ways in which assets can be bound with debt.

A borrower may leave the lender in control of some asset while the loan is outstanding.  This is how pawn brokers work, for instance.

One of the best forms of security is a registered first mortgage over real estate.  This is the common security required by a bank where there is a substantial loan.

It is possible to have a mortgage over assets other than land.  Cars and household goods can be mortgaged.  Land is a good asset to use for security because it has registered ownership and cannot be moved, lost or stolen.  It is less susceptible to damage, wear and tear than goods.

If you have a mortgage and the loan is not repaid, you have the power to sell  the property to recover the debt.  A mortgage can prevent dealings with that property contrary to your interest.

If there is already a mortgage over the property you can take a second mortgage.  Your rights would be subject to the claim on the property by the first mortgage.

If you need more information on mortgages ask Tierney Law for our booklet on that topic.

What does it cost to have a loan secured?

Mortgages or charges over property are no longer subject to stamp duty but there will be a government fee to register the mortgage or the charge of approximately $100.00.  There will also be lawyers fees that  will vary according to the circumstances, but are likely to be at least $300.00.

Take specific advice on the costs before proceeding with any loan.

Is security enforced only against the borrower?

Securing a loan protects the lender against other people claiming against the borrower.

In financial crisis, the borrower may want to pay but be unable to.

Lenders sometimes compete to get paid.  Lenders with secured have the advantage over lenders without security.

More than one lender may have security against an asset and need to take turns to claim from the proceeds of sale.  The holder of the first mortgage will be paid first.  Holders of subsequent mortgages will then be paid in order and lenders without security will be paid last.

The asset may be sold for less than the amount that is needed to clear all loans.

How much security do I need?

You need enough security to make sure you get paid.

How much you need is a matter for judgment.  What is reasonable is a matter of circumstances.  Assess your circumstances.

There is always some risk you will not be repaid.

Securing a loan is an insurance and risk management exercise.

Judge how much risk you want to take and how much trouble and expense you wish invested to get security.

Your loan is as safe as the borrower’s ability to pay and your ability to force payment if you need to.

The value of any security is dependent on the extent of the borrower’s interest in the property.  Does the value of the property offered as security exceed the loan value?  Will a sale cover the loan amount?  Will the sale cover the loan amount safely taking account that a forced sale may realise a lower than usual market price?

Is the expense of security justified?

As an insurance and risk management exercise, assess the extent to which money spent on security is cost effective.

Often the borrower will pay the costs of providing the security.

Is the expense of registering a mortgage justified?

Sometimes to save the cost of registering a mortgage, the parties have it prepared but left unregistered.  An unregistered mortgage binds only the parties who have knowledge of it.  People without knowledge of the unregistered mortgage may claim against the property.

Is there a cheaper alternative to a mortgage?

If a mortgage is not possible or practical, the borrower could charge property with the loan.  A charge would allow you to prevent dealings with the property without repayment of your loan.  You would be able to apply to the court for an order that the property be sold, but you cannot immediately proceed to sell the property without court orders.

A charge against real estate can be registered against deeds by a caveat a warning note on the title that limits dealings with the property contrary to the claimed interest.

Do you need to have someone guarantee the borrower?

If you are unsatisfied with what the borrower offers by way of security and the prospects of repayment, you may require another person to guarantee the debts are paid.  That in turn may involve security over that other person’s property.  If the borrower breaks the agreement, you can take action against the person giving the guarantee, or that person’s property.

How do we know what is repaid?

Make sure there is a comprehensive record of payments.

It is too easy to lose track of what payments have been made, for what purpose and when.

A duplicate receipt book kept by the lender is simple and easy.  The borrower keeps the signed receipts as issued by the lender and the lender has the duplicates contained within the book.  Another alternative is a designated bank account used by the borrower for all payments.

Can I rely on friends and family?

An old saying warns that if you lend your friend an umbrella, you will lose both the umbrella and the friend.

Be careful with friends and family because you have more to lose than the loan.

Think beyond reliance on the relationship as friend or family.

The person you are now dealing with may lose control of their affairs.  They may need to establish the amount and the basis of funds paid as part of a matrimonial property settlement .You may not end up dealing with the person with whom you now have the relationship.  You may end up dealing with their executors after their death or their creditors after a financial disaster.

What if the loan is in the course of my business?

If, as part of your business, you make loans that the borrower use for personal and domestic purposes, you will need to comply with the provisions of the National Credit Code.

The National Credit Code applies not only to lenders whose principal business is lending, but also covers some transactions where a loan is a subsidiary to the major transaction; For instance, a line of credit to purchase goods.

There is a comprehensive set of requirements under the National Credit Code and the consequences of breach are serious.  If the lending is related to your business and is for personal and domestic use to the borrower, talk to Tierney Law for specific advice.

What is vendor finance?

Sometimes a vendor will lend to a purchaser.

Vendor finance may be offered to win a sale or may just be a happy coincidence of the vendor wanting a loan investment and the purchaser wanting to borrow.

Apart from the coincidence of the vendor being the lender and the purchaser the borrower the same loan issues as discussed above apply.

Vendor finance can be secured by property other than that sold.

If the sale agreement is based on vendor finance, the contract should deal with the loan terms in sufficient detail.

Will I lend?

Loans are risky.  Sometimes the risk is worth taking.

Assess the loan risk.  Assess how best to minimise the risk.

Talk to Tierney Law for more advice or assistance on documenting your loan.

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