Even the owner of a successful business can encounter an occasional financial setback and cash-flow problems, which prevent them from making the scheduled payments on their commercial property loan. But unless they take immediate action at the first sign of distress, they could end up jeopardizing the future of their business and forgoing the equity in their property.
Fortunately, committed owners with a viable business model may qualify for a loan modification, which gives them a chance to regroup or wait out an economic downturn by temporarily lowering their loan payments. However, owners need to do their homework and research their options before reaching a decision.
“Modifications are a great tool, but they’re designed to relieve a temporary situation,” says Seung Hoon Kang, senior vice president and chief credit officer for Wilshire State Bank. “If things don’t improve and owners fail to make the modified payments, then banks have the right to foreclose on the property or force a short sale.”
Smart Business spoke with Kang about the options for commercial borrowers who undergo a financial setback and the best way to approach a lender about a loan modification.
When should borrowers consider a loan modification?
Borrowers who run short of cash because of the poor economy or a prolonged seasonal downturn may qualify for a temporary reduction in their mortgage payments by requesting a modification. Businesses and individuals who own commercial properties such as strip malls, gas stations, car washes, hotels, motels, apartments or office buildings will be considered. But remember that borrowers are required to pass along any reductions to tenants, so everyone has the opportunity to recover. If a loan officer grants your request, your payments may be reduced for up to six months so you can continue operations. However, you’ll be required to repay the concessions once the economy improves, which is why a modification is only an interim solution.
How does a loan modification differ from a short sale or foreclosure?
A loan modification is appropriate when an owner wants to continue the business and preserve any equity in the property. If the borrower owes more than the property is worth, or doesn’t want to revive the business, then a short sale or foreclosure may be the best option. A short sale requires the lender’s approval, and allows the owner to sell the property for an agreed upon amount that is usually less than what is owed. If the bank forecloses, it assumes the property and the borrower will be forced to vacate and concede any equity. In some cases, banks may be willing to permanently modify a commercial loan by extending the length of the note or reducing the interest rate, which is the best solution for situations that are expected to exceed six months.
What should property owners know about the modification process?
Be sure to contact your lender at the first sign of trouble, because the approval process takes about four weeks. Realistically assess your situation and your options, since you’ll have to substantiate your inability to make your payments and the reasons why your business will thrive once the economy improves. Remember that lenders will consider your ambition and sincerity as well as your business plan, because it’s hard to revive a struggling business and long-term survival requires a committed and enthusiastic owner.
What’s the best way to approach a lender about a loan modification?
Make an appointment to meet with your lender and be ready to present your case by bringing a copy of your business plan, P&L and your latest rent roll, if the property is tenant-occupied. You’ll also need to provide a hardship letter that explains your situation and the reasons you can’t make your payments. In many respects, requesting a modification is like applying for a loan, because lenders will be evaluating your business strategy and the competition and assessing your ability to run the business as well as the feasibility of your model.
Why do so many modifications fail and how can business owners avoid a similar fate?
Borrowers frequently overestimate their ability to bounce back from a downturn and what will happen if they fail to make the modified payments. At that point, they lose the ability to control their own destiny, because the bank has the right to immediately foreclose on the property or force a short sale. Sometimes the situation requires more than a short-term fix, in which case the owner should consider other options and attempt to refinance the loan or negotiate a permanent modification.
Do you have any other advice for commercial property owners?
Do your homework and beware of advertisements from firms offering loan modification assistance, because they may paint an unrealistic picture of your chances or provide misinformation just to earn a fee. Listen to your loan officer, because he or she will know the best course of action after assessing your situation. Ask how each option will affect your credit and consider the long-term implications when making your decision. Finally, don’t ignore a financial setback or letters from your lender, because the situation will not go away and ignoring communications gives your lender the false impression that you simply don’t care.
Seung Hoon Kang is a senior vice president and chief credit officer for Wilshire State Bank. Reach him at firstname.lastname@example.org.