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A personal guarantee is a legal and financial commitment by a real estate owner to pledge personal assets to secure a commercial real estate mortgage.
Borrowing a commercial real estate loan can be an important step to fund a real estate acquisition, expansion or development. However, to mitigate their risks, lenders often seek additional financial assurances from a prospective borrower. A personal guarantee is one such assurance that lenders may require to issue a commercial real estate loan.
In this blog post, you will learn:
A personal guarantee is a legal and financial commitment from an individual real estate owner who pledges personal assets as collateral for a commercial loan. If the borrower, who is also known as the guarantor, defaults on the real estate loan, the lender can pursue the guarantor's personal assets to pay back the real estate loan.
You may be wondering why a personal guarantee is necessary to secure a commercial real estate loan. In commercial real estate financing, lenders want to minimize underwriting risk across their loan portfolio to avoid default. A personal guarantee provides lenders with lower risk exposure and provides more confidence that the loan can be repaid if the borrower defaults. When a borrower provides a personal guarantee, a borrower may be more likely to get a real estate loan approved by the lender.
There are several types of personal guarantees, including:
Unlimited personal guarantee. With an unlimited personal guarantee, the guarantor agrees to be liable for the entire loan, including principal, interest and other costs, in case of loan default. If the borrower defaults, the lender can access all of the guarantor's personal assets, without limitation, to recover the debt.
Limited personal guarantee. With a limited personal guarantee, a borrower can limit personal financial exposure by capping liability at a mutually agreed upon amount. If a borrower defaults on a real estate loan, the lender can only recover the borrower’s personal assets up to the agreed upon amount.
In commercial real estate financing, there are several types of borrowers who may be asked to provide a personal guarantee. For example:
However, not every real estate loan requires a personal guarantee. For example, a lender may be willing to enter into a non-recourse loan, which means a lender cannot recover personal assets when a borrower defaults on a real estate loan. Who qualifies for a non-recourse loan? Typically, a borrower with a strong financial position and track record of financial success may qualify for a non-recourse loan. However, each lender decides whether a non-recourse loan is appropriate given the specific circumstances and borrower profile.
If you are asked to provide a personal guarantee, it’s important to understand the potential implications and risks. For example, here are some items to consider
Before signing a personal guarantee, it’s essential to explore alternatives to a personal guarantee. For example, consult with other banks and lenders that may not require a personal guarantee and who are open to non-resource financing.
Are there any alternatives to a personal guarantee? In many cases, a personal guarantee is required for many borrowers who seek commercial real estate financing. However, here are some ways that a borrower can reduce their financial exposure:
While real estate lenders use a personal guarantee to reduce their risk profile, borrowers risk their personal assets in case of loan default. Borrowers should understand all aspects of a personal guarantee, including both benefits and risks, before agreeing to a personal guarantee. While a personal guarantee may be necessary to secure financing, borrowers should also be careful to protect their financial assets.