Fees and Upfront Charges
(Courtesy Blackburn and Sons)
One of the trickiest subjects in the field of commercial real estate finance is the subject of application fees. There are a lot of con men out there trying to steal application fee money from innocent commercial borrowers.
An application fee is a fee charged by charged commercial real estate lenders and by commercial mortgage brokers to underwrite a borrower's loan, to usually pay for third party reports, and to pay for the broker's time and costs in arranging a commercial real estate loan. Application fees can range anywhere from $500 to $200,000.
Virtually all legitimate commercial real estate lenders, including most commercial banks, have to charge some sort of application fee in order to pay for the appraisal, the toxic report, the engineering report, and the title commitment. The fee typically charged by most legitimate direct lenders is between $4,000 and $12,000. This is a very legitimate charge because these are very legitimate expenses.
It gets tricky, however, when mortgage brokers charge an application fee. If the mortgage broker is only charging, say, $500, this fee is arguably reasonable in light of the time and effort the broker will have to invest in order to see if the loan is reasonably do-able. It's not his fault if the borrower's credit turns out to be poor or if the borrower has grossly misrepresented the value of his property. And after all, lawyers charge for their time. Accountants charge for their time. Why not a commercial mortgage broker?
The problem lies in the fact that too often a commercial mortgage broker will flat out lie to the borrower in order to sucker him into paying a $500 application fee. Too often a commercial mortgage broker will say, "Sure, Mr. Borrower, your deal sounds very do-able. Just send in your $500, and we'll get started," when in fact the broker knows that the deal doesn't have a snowball's chance."Aye, there's the rub." After receiving the $500, the crooked broker usually stops returning phone calls. But we're only talking about $500 or so here.
Where things get really ugly is when a broker pretends to be a direct lender in order to outright steal a big application fee. The scam starts like this: The smooth talking "broker" tells you that he is a direct lender and quotes you a 6.5% rate on a commercial loan in a 7.5% market. Then he issues a very impressive looking term sheet that looks legit. All he needs is a $25,000 application fee to get started.
Unfortunately, once you sign the term sheet and send in your money, you never hear from the "broker" again. Your $25,000 fee is history, and unfortunately very few city or state governments ever pursue white collar criminals. Then, when you try to sue the mortgage company, you learn that the company has no assets and your loan officer has been using a fake name. You're toast - just one more victim.
What is a term sheet anyway? A term sheet - also known as a conditional commitment letter, a proposal letter or a good faith letter - is a written expression of interest by a lender in making a commercial real estate loan and a good faith estimate of the eventual terms. A term sheet is not a commitment letter. It is not legally binding on the lender, but in practice it is a very positive and encouraging statement. If your borrower receives a term sheet, it generally means that his loan is going to be approved, assuming the property appraises for enough money and the toxic report comes back clear.
The problem here is that the term sheet is not being issued by a legitimate commercial real estate lender.
Okay, you've found someone who says he can make you a good commercial real estate loan, but he wants a $8,000 application fee. Is he legitimate? How can you be avoid becoming a victim to loan fraud?
- It's far safer to work with a bank than with some strange "mortgage company" that you have never heard of. And remember, virtually all banks legitimately require an application fee. So if you have applied directly with a bank with whom you are familar, you'll probably be okay.
- However, be careful of brokers illegally using the word "bank" or "banc" in their company name, such as Lillypad Bancorp Mortgage. To me that's a red flag that something might be hinky.
- In any case, never pay for an advance fee until the lender has issued a term sheet.
- If a mortgage broker is asking for an application fee of larger than $500, watch out. You may be about to be fleeced.
- If the mortgage company says that they are a direct, hard money lender, and they want an application fee of $6,000, that might be legitimate.
- However, be sure to look at their website. Hard money outfits are typically substantial operations. They should have a professional and fairly extensive web site.
- Finally, be sure to Google both the name of your loan officer and the name of your commercial mortgage company before shelling out any cold, hard cash. You can sometimes find all sorts of derogatory information about crooks on the web.
- Trust your instincts. If something doesn't sound right, don't get sucked in by a promise of a 6.5% commercial loan in a 7.5% market. If it's too good to be true, it probably is.
- Lastly, try to remember that con men are often very, very believable. In fact, an old boss of mine in the finance business once told me, "George, if there is a room full of 30 guys, and you know that one of them is a con man, pick the one guy who you are absolutely sure is not the con man ... and 99% he will be your con man."