Personal Guarantees in Commercial Real Estate Financing: A Comprehensive Guide

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:

1. What is a personal guarantee?
2. Why a personal guarantee?
3. Examples of personal guarantees
4. Who provides a personal guarantee
5. Personal guarantees: key implications
6. Alternatives to a personal guarantee

What is a personal guarantee?

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.

Why a personal guarantee?

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.

Examples of personal guarantees

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.

Who provides a personal guarantee

In commercial real estate financing, there are several types of borrowers who may be asked to provide a personal guarantee. For example:

• Small Business Owners: A small business owner with a limited operating history or unstable financial history may be asked to provide a personal guarantee to access a real estate loan.
• Entrepreneurs: An entrepreneur without an established track record may be asked to provide a personal guarantee to secure a real estate loan.

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.

Personal guarantees: key implications

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

• Personal Asset Risk: When you sign a personal guarantee, you are putting your personal assets – such as your home, car, investments, savings – at potential risk. If you default on a real estate loan, and your lender seeks to recover the debt through your personal guarantee, your assets could be seized for debt repayment.
• Credit Score Impact: Understand the impact to your credit score when you provide a personal guarantee. For example, if you default on a loan, your credit score can be adversely impacted.

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.

Alternatives to a personal guarantee

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:

• Additional Collateral: Rather than a personal guarantee, you may be able to provide a bank an alternative asset as collateral.
• Strong Financial Position: If you have a strong financial position, positive credit history, and established track record, you may have more leverage to negotiate with a lender to not require a personal
  guarantee.
• Alternative Capital Sources: Rather than a traditional commercial real estate loan, consider alternative financing sources such as equity or mezzanine financing. Alternatively, you can seek financing from a non-bank lender who may not require a personal guarantee. However, private non-bank lenders may charge a higher interest rate for debt financing compared to a traditional commercial real estate loan.

Conclusion

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.

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