When we spoke with our resident loan experts about the most challenging aspects of loan abstracting, one surprising issue stood out: errors in loan documents. While most mistakes are minor, some can create significant confusion and potentially impact the terms of your loan.
Loan documents are drafted by humans, and even the most diligent lenders are not immune to errors. To help borrowers navigate this, we’ve compiled a list of the most common mistakes our abstractors encounter and the questions borrowers should ask to clarify critical terms.
1. Incorrect or Ambiguous Prepayment Dates
Prepayment terms are crucial, especially if there’s a chance of disposition before maturity. However, errors or vague language can complicate strategic planning.
For example, if a prepayment schedule specifies a flat percentage penalty from January 1, 2021, to January 1, 2024, and no penalty thereafter, what happens on January 1, 2024? Does the penalty apply, or is it waived? This ambiguity often requires clarification with the lender.
Another common issue involves inconsistent schedules, such as:
“2.00% Flat Percentage for the 1st, 2nd, and 4th years; 1.00% Flat Percentage for the 3rd, 5th, and 6th years.”
This type of error, while rare, can disrupt planning since the 3rd and 4th years are pivotal for dispositions in many portfolios. Borrowers should confirm these details with their lender early on.
2. Prepayment Calculation Methodology
Prepayment penalties often involve complex calculations, and errors here can lead to costly surprises. The two most commonly confused methods are Yield Maintenance and Make Whole:
- Yield Maintenance: Calculates the difference between the present value of future interest payments at the note rate versus the market rate, summed to determine the penalty.
- Make Whole: Calculates the present value of all future payments using a replacement rate, subtracts the outstanding balance, and arrives at the penalty.
While the methodologies yield similar results, discrepancies in the replacement rate can significantly impact the final calculation.
For example, if your loan documents omit open periods or include an unintended addition to the replacement rate (e.g., T+50bps), you may drastically under-calculate your penalty. Such oversights can result in penalties far exceeding initial estimates, potentially costing hundreds of thousands of dollars.
3. Inconsistent Floor Language
Loan documents often rely on templates, which can lead to inconsistencies when terms are adjusted. A common error involves conflicting language around interest rate floors.
One section might state:
“Under no circumstances will LIBOR be below 0%,”
while another reads:
“If LIBOR falls below 0.25%, the floor will default to 0.25%.”
When LIBOR is 10bps, which floor applies? Such discrepancies create unnecessary confusion and may affect your monthly debt service.
4. Conflicting Maturity Dates
Finally, loan documents sometimes include conflicting maturity dates between the Note and the Loan Agreement. While this is often a simple typo, it complicates your ability to plan effectively. Borrowers must confirm the correct maturity date with their lender to avoid misunderstandings.
Double-Checking Loan Documents: A Crucial Step
Errors in loan documents are rarely intentional but can create significant challenges for borrowers. Carefully reviewing your documents and seeking clarification on ambiguous terms can save time, money, and frustration.
When in doubt, don’t hesitate to consult a loan expert to ensure your critical terms and calculations are accurate. After all, clear and precise documentation is key to managing your portfolio with confidence.
