Banking Law

Banking and Finance FAQs

By Tom Pedreira, Attorney

Q: Can I change my mind after I sign the paperwork on a loan?

  • A:There are consumer protection statutes that sometimes give borrowers a cooling off period when they can change their minds. The Truth in Lending Act, for example, gives a consumer the right to cancel certain real estate loans within three business days without penalty. However, it's critical to understand that these protections will usually apply only to limited consumer transactions. The chances are that they won't apply to a business or commercial loan.

Q: Does it may any difference what kind of property is put up for collateral?

  • A:Yes. There are big differences in the rules that apply to personal property versus real property. The term "personal property" refers to equipment, household goods, vehicles and most anything that is not a land or a building. Land and buildings are real property. (Examples of property that sometimes lands in the middle would include items called fixtures, which would usually be considered personal property, except that they are attached to real property. Other examples would include things like mobile homes, crops and trees.)

    If collateral is personal property, a lender will want to perfect the lien by following the rules of the Uniform Commercial Code (UCC) , which provide for filing a financing statement with the Secretary of State in the state where the equipment is located. The UCC financing statement is a public record that puts other creditors on notice of the lien and gives it priority over any subsequent claims on the same equipment.

    On a loan secured by real property, the lender will want a mortgage from you. In some states, this is called a deed of trust. Whatever the document is called in your state, it gives the lender the right to foreclose on the property if you default.

Q: How and when do personal guarantees come into the picture?

  • A:Lenders don't make money unless their loans are paid back. So a lender will want to do everything possible to make sure a loan is repaid even if the borrower defaults. A very effective way to do this is to require as a condition to making the loan that one or more persons "guarantee" the obligation. What this means is that anyone guaranteeing a loan (called the "guarantor") is agreeing to put his or her personal assets on the line to pay back the loan if the borrower fails to do so.

    One common situation where guarantees come into play is with a loan to a borrower with little credit history or without enough net worth for a lender to be sure of repayment. Even if there's collateral for the loan, a lender may still not be able to get enough money on a foreclosure to pay off the loan. And lenders don't like foreclosures, because they can be time consuming, difficult and expensive. So a lender may insist on a personal guarantee from someone else in addition to the borrower, someone who would be a better source of recovery if the borrower defaults. Oftentimes, it will be a family member or business associate who's called upon to provide the guarantee.

    Another common situation where a guarantee will be required is with a loan to a small business that has been organized as a corporation or some other type of legal entity that protects owners from liability (for example, a limited liability company). Most of the time, a lender in this situation will insist on a personal guarantee, so that the owners are on the hook personally for any credit extended to the business.

    Sometimes more than one person will be obligated on a loan. With what's called a "joint and several obligation", the lender could come after:

    • One of the debtors
    • Some of the debtors or
    • All of the debtors

    If an obligation is guaranteed, the terms of the guarantee may require the creditor to go against the primary debtor or foreclose on collateral first before coming after you if you happen to be the guarantor. Chances are, though, that you signed a guarantee that allows the creditor to come after you at any point in time without even first having to go after the borrower.

    A different way to refer to a guarantor is as a "surety" for a loan. If you're looking for laws that apply to guarantees in your state, you may want to look under this term as well, as many state statutes make reference to it rather than to the term "guarantor."

    State surety laws sometimes give protections to guarantors that can be really frustrating for lenders. For example, the law may provide that modifying or amending an underlying obligation will let a guarantor off the hook unless the guarantor agrees to the amendment or modification. As a result, most guarantees require a guarantor to waive those protections to the broadest extent possible.

Q: How much interest can a bank charge?

  • A:The lending industry is heavily regulated as to what can be charged for interest rates. Each state has maximum limits that can be charged. The limits are usually established on the basis of annual percentage rates applied to the outstanding principal balance on a loan. Banks and other financial institutions are usually allowed to charge higher rates, but they must go through a rigorous licensing process before they're allowed to do so.

    The charging of excess interest is call "usury." If you're charged too much interest, the penalty is sometimes that all interest is waived. Where this is most likely to happen is with a loan between private individuals. Banks and other financial institutions are generally sophisticated in their lending practices such that they don't step over the line in charging interest.

    There are also lots of ways to assess loan charges that technically may not be considered interest. Common examples would include late charges, charges for exceeding your credit limit, charges for excessive use of leased property.

Q: If I'm trying to finance my business, are there any other options?

  • A:Small business startup costs are often financed with personal funds including savings, loans from family members and even credit card advances. But if your business is to grow, it's usually necessary to find larger amounts of financing than these methods can provide. Sometimes, a better alternative may be to raise equity for the business rather than borrowing money. To raise "equity" means to bring in additional owners who make capital contributions to the business, rather than loaning money.

Q: Is leasing any different than financing?

  • A:Yes. Leasing means renting something rather than buying it. The person renting is the lessee. The lessor is the financial institution or other business that is renting out the property. Legal title to the property stays with the lessor, but the lessee has the right to use it under the terms of the lease. The lessor has the right to keep the property at the end of the lease term, unless the lessee elects to buy out the lease. However, lenders and other finance companies have become so creative with financing and leasing arrangements that it is sometimes difficult to tell the difference between the two.

Q: On what basis can a bank turn me down for a loan?

  • A:Banking is regulated by many federal and state laws and regulations, including laws prohibiting discrimination in lending practices. These laws are designed to help protect consumers from shady leaning practices. Nevertheless, the practicalities of the situation are that there are so many valid reasons a bank could turn you down for a loan that it would be a rare case where you could prove it was for an illegal reason. One of the most common reasons is that you don't meet one of their conditions for extending credit. Prior credit history (or lack thereof), too much existing debt, or not enough collateral are often reasons given.

Q: So why would anyone ever want to lease anything?

  • A:Some of the benefits of leasing may include:

    • When you lease instead of purchase, you do not have to pay for the full purchase price of the equipment. You only pay for the cost of renting the property for the period of time it's used. This keeps monthly payments down, which improves cash flow in a business setting.

    • You may be able to expense some or all of the lease payments so as to realize any tax benefits sooner than equivalent payments on equipment that is purchased (which must be depreciated).

    • Terms might be more flexible to accommodate your needs.

    • Leasing can help to avoid obsolescence if you are able to use equipment for the term of the lease and then roll into a new lease with upgraded models (for example, computers).

    • Some leases may not have to be "capitalized." This may help an already debt-laden company show better financials if the lease does not have to be listed on the balance sheet as a liability.

Q: What are some of the benefits of financing a purchase instead of leasing?

  • A:The benefits of financing a purchase can include:

    • You actually buy the property, which means that you get to keep it after the loan is paid off. You are not then surprised as you might be at the end of a lease term where you would either have to return the property or make a substantial residual payment on a "buy out" charge.

    • You may have more flexibility to refinance or pay off a loan early as compared to trying to buy out or terminate a lease.

    • Interest rates on a loan may be more favorable than the financing charges on a lease (or at least more understandable).

    • There may be fewer limitations on use or operation of the equipment. If you lease a car, for example, you may be limited on the number of miles you can drive during the lease. There can be substantial penalties if you exceed your mileage allowance.

    • There will be fewer unexpected charges and penalty clauses at the end of the loan term (for example, charges for driving too many miles on a leased car).

Q: What can a bank do to try to collect a past due debt?

  • A:A creditor can try to collect the debt directly. The collection process usually starts with telephone calls, followed up with letters. Ultimately, most creditors will end up turning the obligation over to a collection agency. The collection agency will usually be paid a percentage of anywhere up to 50% of whatever they collect on a debt.

    The Fair Debt Collection Practices Act requires that debt collectors treat you fairly and prohibits certain methods of debt collection. Of course, the law doesn't erase any legitimate debt you owe. Personal, family and household debts are covered under the Act. This includes money owed for the purchase of an automobile, for medical care or for charge accounts. However, a business or commercial loan may not be covered by the Act.

    The Act specifically applies to any debt collector, defined as any person who regularly collects debts owed to others. This includes attorneys who collect debts on a regular basis.

    A collector may contact you in person, by mail, telephone, telegram or fax. However, a debt collector may not contact you at inconvenient times or places, such as before 8 a.m. or after 9 p.m., unless you agree. A debt collector also may not contact you at work if the collector knows that your employer disapproves of such contacts.

    There are ways to stop the collection process. You can stop a debt collector from contacting you by writing a letter to the collector telling them to stop. Once the collector receives your letter, they may not contact you again except to say there will be no further contact or to notify you that the debt collector or the creditor intends to take some specific action. However, sending such a letter to a collector does not make the debt go away if you actually owe it. You could still be sued by the debt collector or your original creditor.

    Prohibited debt collection practices include harassing, oppressing or abusing you or any third parties they contact. Debt collectors may not use any false or misleading statements when collecting a debt. They cannot, for example, tell you that you are going to be arrested.

    You have the right to take your own legal action by suing a debt collector in a state or federal court within one year from the date the law was violated. Court costs and attorney's fees also can be recovered. However, you would probably have to have a really strong case before a lawyer would be willing to represent you on a contingency fee basis. If you have problems with a debt collector, though, another option would be to report the matter to your state attorney general's office and the Federal Trade Commission. Many states have their own debt collection laws, and your attorney general's office can help you determine your rights.

Q: What is a lender required to tell me up front about the terms of a loan?

  • A:Lenders are required to tell you certain things before you sign on the dotted line. The Truth in Lending Act, for example, requires disclosure of the essential terms and costs of a loan, including:

    • The annual percentage rate
    • Points and fees
    • The total of the principal amount being financed
    • Payment due date and terms, including any balloon payment where applicable
    • Late payment fees
    • If there are variable interest rates involved, the Act requires that you be told the highest rate the lender would charge, how it would be calculated and the resulting monthly payment
    • The total finance charges
    • Whether the loan is assumable
    • The amount of any application fee
    • Any annual or one-time service fees
    • Pre-payment penalties
    • If you are taking out a loan secured by collateral, the lender may also be required to confirm for you the address of the property securing the loan

Q: What is "financing?"

  • A:Financing means borrowing money by taking out a loan to buy something.

    There are all kinds of different loans.

    The simplest type of financing is a demand loan. This means that the loan is payable any time the lender gives you proper notice demanding payment Given that there is a lot of risk involved in running any business, demand loans are quite common in business settings where lenders want the security that they can "call" their loans at any time.

    Another common type of financing is a term loan, where you borrow a specific amount of money and promise to pay it back over a period of time. The amount you borrow is called the "principal." A term loan is usually repaid in installments. Each payment is first applied to accrued interest, with the remainder used to reduce the outstanding principal balance. The timing of the installment payments over the term of the loan is called the "amortization schedule."

    A line of credit is a non-binding commitment by a lender to lend up to a specific amount from time to time. Lines of credit usually don't exceed one year but may, at the lender's option, be renewed yearly.

    A revolving credit loan is similar to a line of credit. It is what you have on your credit cards. The lender commits to loan up to a specific amount from time to time as required by the borrower. Unlike a line of credit agreement, the bank is obligated to lend the amount requested by the borrower as long as, at the time of each request, the borrower is in compliance with all the terms and conditions of the loan agreement. Amounts borrowed and prepaid may be re-borrowed during the term of the agreement so long as the total amount of borrowed funds at any one time isn't more than a preset maximum amount. Revolving credit loans often have other requirements regarding renewing the loan or requiring repayment of the entire amount of the loan.

Q: What is the worst thing that can happen to me on an unpaid debt?

  • A:It depends on whether you have been completely truthful and forthright in all your dealings with the lender. There are laws, for example, that make it a crime to intentionally provide false information to a lender when obtaining a bank loan. Assuming you don't have any concerns about criminal fraud or other intentionally wrongful acts, there is no longer any debtor's prison. So the worst-case scenario is usually that the lender or a collection agency can foreclose on collateral, if any, and sue you (and any guarantor) to recover amounts owed on the debt. This may force you into bankruptcy, where you may be able to discharge the debt.

Q: What kind of loan documents need to be signed if I want to borrow money from a bank?

  • A:Typically, you will be asked to fill out a loan application, which has credit information about you that the lender will rely upon in deciding whether to make you a loan. If you are deemed to be credit worthy, a loan agreement will oftentimes be prepared that sets forth the general understanding and agreement of the parties. It will also contain provisions requiring you to guarantee that the information you've provided is true and accurate.

    In addition, a promissory note is usually the most important document that you'll be asked to sign. It contains the critical terms of your loan, such as the principal amount borrowed and the interest rate. The promissory note will also set forth what is usually an unconditional promise on your part to pay back money in accordance with the terms of the loan.

    If you are being given an unsecured loan, there may not be a lot of other documentation you'll be asked to sign. But if the lender is giving you a secured loan, you'll be required to sign additional documentation to give the lender a security interest in property that will be collateral for the loan. This will give the lender a lien on the property, with the right to repossess or foreclose on the property if you default on the loan.

Q: What makes me legally obligated to pay back a loan?

  • A:If push comes to shove, the reason that you can be forced to pay back a loan is because it is a legally enforceable contract. Courts enforce contracts in order to protect the expectations of the contracting parties. A loan can be enforced in court even if it is based only on an oral understanding, such as might be the case of someone helping out a friend in a pinch. However, banks and other financial institutions are in the business of loaning money, so they will always put their loans in writing to make sure that there is no misunderstanding as to how they are supposed to be repaid.

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