“The paper companies must be in collusion with the federal government.”
That’s a quote from one of my clients after sitting through a recent loan closing — stacks of papers with no end in sight. Why so much paper? That is your government at work trying to protect you. This excess paperwork problem is particularly true with a home mortgage or an SBA business loan, where government regulation reigns supreme. Admittedly most of you are not going to read all the pages you are asked to sign; however there are four important documents that each of you should carefully consider whenever you are part of a loan closing:
1. Promissory Note. This document is the heart and soul of any loan transaction. It sets out the amount of loan principal, the interest rate, the payments terms, and the due dates for the loan. Review all of these items carefully before you sign the note because this one document will usually control all others if there is any dispute later. The Promissory Note has been specially developed under the law to allow the lender to obtain a quick judgment in the event of a loan default. This is why confirming the accuracy of the terms of the Promissory Note is so important.
2. Deed of Trust or Security Agreement. Almost every loan will require some form of security such as real estate or business assets; this provides the lender a resource for collection in the event of a loan default. In North Carolina a Deed of Trust is filed with the Register of Deeds to provide the lender with a security interest in your real estate. For equipment or business assets, you will sign a Security Agreement and the lender will file a UCC notice form with the Secretary of State in the name of the borrower. Make sure you look carefully at the description of the property or assets being pledged in either of these documents to confirm that it does not include any property not intended as security.
3. Guarantee. I reviewed the ins and outs of Personal Guarantees in my April 2010 newsletter. This is often a standard document included in business loans. The business owners are required to sign Personal Guarantees to ensure that the lender can collect on the Promissory Note if the business doesn’t have sufficient assets to pay. Signing a Personal Guarantee is effectively the same as signing the Promissory Note. Remember that a Personal Guarantee will usually obligate you to repay the lender regardless of any attempts to collect on the Promissory Note or against the security interest.
4. Loan Agreement. Many business loans also include a Loan Agreement, which includes various covenants concerning the operation and continued financial performance of the business. Please pay attention to these covenants. Do not assume that if you make your loan payments on time, you are in good standing with the bank. If the bank believes that your loan may be at risk in the future, it can and will enforce the various loan covenants and call the loan for immediate repayment.
If you are flipping through a large stack of loan documents, as you come to the items discussed above please slow down and look at everything carefully. These documents will have plenty of boilerplate terms, but pay attention to the main points noted above to make sure what you are signing is accurate. By all means, if you find a mistake, have it corrected before you sign anything. It is much easer to correct everything before the transaction is closed, even if that imposes a little delay.
My parting request — the next time you refinance your home mortgage, be sure to plant a tree as well.