One of the most important documents you will ever sign with a private lender is the actual Note that creates the loan obligation. The Note is where you want to control the private lending process in your favor and give you the borrower the control and flexible you may need in the future. This article lays out two critically important clauses that give you this control and flexibility.
Copyright (c) 2008 Michel Lautensack
One of the most important documents you will ever sign with a private lender is the actual Note that creates the loan obligation. In a typical private lender transaction, you the real estate investor (borrower) borrow money from a private individual (private lender) and that transaction is documented by a Note and Mortgage.
The Note lays out the terms and conditions under which the private lender is willing to lend you money and under which you are willing to borrow money. The Mortgage is the security document for the borrower's performance under the Note and usually is secured by a piece of real estate you own or are about to purchase.
The Note is where you want to control the private lending process in your favor and give you the borrower the control and flexible you may need in the future. If the Note does not have the right clauses contained within it, you are potentially giving away tremendous control to your private lender and tying your hands.
When dealing with private lenders it is critically important that you remain in control of your future options.
If you were to go to your local Staples and buy one of those template note forms you are potentially leaving your future control over to your private lender without even knowing what is happening.
We recommend the following two clauses in any Note with a private lender.
Prepayment Penalty Clause: "The Borrower reserves the right to prepay this Note (in whole or in part) prior to the due date with no prepayment penalty"
The prepayment penalty clause allows you the borrower the right to pay off a Note prior to maturity without a prepayment penalty. Without this clause, you may not be able to pay off a Note early or worse yet you may have to pay a large penalty for the right to prepay the Note.
For example, if you have a three year Note secured by a piece of real estate you own and you get a great offer to sell the property. You see a big pay day in your future. But without the above clause you may have to pay the lender their full interest for the three years for the right to pay off early or the lender may require a penalty of several percentage points to allow you out of the Note.
With the prepayment penalty clause outlined above you have the full right to pay the Note off early with no prepayment or interest penalty. The benefits of this clause can be very powerful and beneficial to you the borrower.
Substitution of Collateral Clause: "Borrower has the right to substitute like collateral of equal or greater value". The substitution of collateral clause allows you to sell the underlying real estate without paying off the private lender Note by substituting the collateral with a different piece of real estate of equal or greater value.
With this clause you can flip a property without having to pay off your private lender every time you sell a property. Imagine the work and inconvience to you and your private lender if every couple months you sell a property and have to them off. Then a couple weeks later you call them to reborrow the money and now you have to sign all new paper work. This can be real burden on both of you and eventually the private lender will tired of the process.
A much better solution is to use the above clause and every time you want to flip a property you have the right to transfer the Note to another property of equal or greater value without paying off the private lender. The private lender is much happier because his money is always working without any inconvenience of new documents every couple months.
Be sure to use these two clauses and months or years down the road when you have a big payday coming by selling a piece of real estate you will have the flexibility and ability to realize that payday.
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