Difference Between Commercial Loan Workouts and Commercial Loan Modifications

So what's the difference between commercial loan workouts and commercial loan modifications? Commercial loan workouts have been around for years to help commercial borrowers "workout" a plan to catch up on their mortgage obligation. But how did commercial loan modifications come into the picture? First, lets give a little background on commercial real estate.

Due to the real estate crisis, the past few years, the buzz word was "loan modifications" for residential mortgages. Now another pending crisis is on the horizon: Commercial real estate. Similar to residential mortgages that were underwritten with liberal guidelines, and a reset feature which increased the mortgage payments after a few years, a tidal wave of commercial mortgages are due to reset with the total mortgage balance due. Most commercial mortgages that were issued during the real estate boom several years ago had loan terms, between 5-10 years with a balloon payment due, when the term expired. Balloon payments were designed to limit investor risks associated with funding commercial mortgage loans. Problem: Commercial property values declined and low demand for leasing space caused cash flows to plummet. Then factor in tighter lender unwriting guidelines, and you have a flood a commercial properties that can't refinance to avoid balloon payments coming due. Making payment arrangements, waiving late fees, or deferring payments could only help so much.

Then enter commercial loan modifications. Commercial loan modifications, a relatively new solution, restructure existing commercial mortgage loans by extending the term period, resetting balloon payments, lowering the interest rate, or in some cases, reduce the principal amount. The purpose of commercial loan modifications are to change the current mortgage to more favorable terms, which the borrower could then afford to pay and get back on track.

Commercial loan workouts are comprehensive solutions, which may or may not include a commercial loan modification. Commercial loan workouts include forbearance agreements, which due to a financial hardship, allow commercial borrowers to temporarily defer payments, make interest-only payments or tack delinquent payments on the end of the loan balance. Commercial loan workouts may also include waiving late fees, or other penalties.

In addition to commercial loan workouts and commercial loan modifications, the lender may approve a deed-in-lieu of foreclosure. A deed-in-lieu of foreclosure allows the commercial borrower to voluntarily transfer the deed to the lender. The lender in turn, agrees not to start the foreclosure process. A key point to remember is the lender may not forgive the mortgage deficiency balance. Always seek the guidance of a tax and/or legal advisor if the lender approves a deed-in-lieu of foreclosure.

Another alterative if the borrower cannot afford to keep their commercial property is a short sale. During a short sale, the borrower retains ownership of the property and attempts to sale the property for less the current mortgage balance owed. The lender agrees to reduce the sales price of the property. A bank lender may opt for a short sale to avoid costly foreclosure proceedings. Sometimes it's not feasible for the bank to own foreclosed real estate. The bank may decide to waive the deficiency balance as a trade-off to taking possession of distressed commercial real estate. But there are no guarantees. Again, seeking the advise of a qualified legal and/or tax professional is recommended.

In conclusion, a commercial loan workout along with a commercial loan modification if needed, will save many distressed commercial properties from going into foreclosure. Already a wave commercial mortgages have defaulted. Borrowers should be proactive in notifying their lender if a financial hardship will cause problems paying their mortgage obligation. Banks and lenders now have more leeway from federal agencies to start the commercial loan workout and/or commercial loan modification process much sooner, even before defaulting on the loan. Problems refinancing, a resetting loan, lower property values or decreasing cash flows are all valid reasons to contact your lender for help. Whether borrowers decide to directly contact their lender or seek the assistance of a third-party for guidance, commercial loan works and commercial loan modifications are valuable tools to avoid losing your commercial real estate.

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