Most borrowers find out a loan was bad after they've already signed. The closing table is not the time to learn that your adjustable rate can jump 5 points, that you have a 3-year prepayment penalty, or that your balloon payment is due in 36 months. By then, you're locked in. The only way to protect yourself is to know what to look for before the documents are in front of you.
Coventry Enterprises LLC, founded by Jack Bodenstein, has reviewed hundreds of loan transactions over the years. The same problems appear over and over. This checklist captures the most common and the most damaging.
1. Prepayment Penalties
A prepayment penalty charges you a fee for paying off your loan early, whether through sale, refinance, or lump-sum payment. Hard money loans routinely carry them. Some commercial loans do too. Even a 1% penalty on a $500,000 loan costs $5,000. A 3% penalty costs $15,000. If your loan has a prepayment penalty, understand exactly when it expires and how it's calculated before you commit.
2. Balloon Payments
Balloon loans require a lump-sum payoff of the remaining balance at the end of a short term, often 3, 5, or 7 years. Your monthly payments may look manageable. The balloon at the end may not be. If you can't refinance or sell when the balloon comes due, you face forced sale or default. Ask directly: is there a balloon payment, when is it due, and what is the expected balance at that time?
3. Adjustable Rate Mechanics
Adjustable rate mortgages start at a low rate and then reset based on an index plus a margin. The key numbers to get in writing are the initial cap, the periodic cap, and the lifetime cap. A loan that starts at 6% with a 5-point lifetime cap can reach 11%. If you're qualifying at the start rate but couldn't afford payments at the cap rate, that's a warning.
4. Interest-Only Periods
Interest-only loans let you pay just the interest for a set period, then require full principal and interest payments afterward. The payment jump when amortization kicks in can be 30-50% higher. Make sure you understand the payment at the end of the interest-only period, not just during it.
5. Negative Amortization
Some older loan products and some current non-QM options allow minimum payments below the actual interest due. The unpaid interest gets added to your principal. Your balance grows instead of shrinks. This is one of the most dangerous loan structures ever developed. Look for any provision allowing a minimum payment option, a deferred interest option, or a payment that can be less than full interest.
6. Excessive Origination Fees
One or two origination points on a commercial or hard money loan is standard. Four, five, or six points is extraction, not lending. On top of that, watch for document prep fees, processing fees, underwriting fees, and administrative charges that don't correspond to any real service. Total fees above 3% of the loan amount on a residential loan are a flag. On commercial, know what's standard for your market.
7. Cross-Collateralization Clauses
This clause lets the lender seize multiple properties if you default on any single loan. If a hard money lender has cross-collateralized three of your rentals and you default on one, all three can be at risk. Always ask whether the loan is cross-collateralized and what assets are pledged.
8. Yield Spread Premiums and Broker Compensation
In some transactions, a mortgage broker earns a yield spread premium from the lender for placing you in a higher-rate loan than you qualify for. The broker gets paid more; you pay more. This practice has been restricted in QM residential lending but still surfaces in commercial and private markets. Ask your broker how they're compensated and whether there's a rate at which their compensation changes.
9. Loan-to-Value and Equity Exposure
A loan that takes you to 90% or 95% LTV leaves almost no equity buffer. If the property value drops even slightly, you're underwater. Lenders who encourage maximum LTV borrowing are maximizing their security without considering your vulnerability. Think about what happens to your position if the market moves 10-15% against you.
10. Recourse vs. Non-Recourse Terms
A recourse loan lets the lender come after your personal assets if the collateral doesn't cover the debt at foreclosure. A non-recourse loan limits them to the property. Most commercial loans are recourse by default unless specifically negotiated otherwise. If you're personally guaranteeing a loan, understand the full scope of what that guarantee covers.
Coventry Enterprises LLC offers independent loan review consulting. See also: toxic lending practices, mortgage fraud awareness, and bad loan types.