It’s October, with Halloween sneaking up on us. I’m probably the only person you know who  scours the bookshelves for Sir Arthur Conan Doyle’s Sherlock Holmes about now. Haunted houses, hounds howling on the moors. On with my deerstalker cap. Up with my magnifying glass. Today’s mystery is twofold. Yet I looked no further than the SOP. Elementary. My dear readers.

MYSTERY #1. Title to a single family home is vested in the commercial borrower. The bank is making a 7(a) loan on the house. Does the house need to be pledged as collateral for the commercial loan? And in fact, can it be pledged?

Some lenders do put a lien on a residence to secure a commercial loan. But how far is too far? I remember an old SBA loan officer who required a lien, first, second or eleventy eleventh, on anything the borrowing entity owned. Regardless of the appraisal or the DSCR, his motto was “They own it, they hypothecate it.” Made it easy to underwrite the few loans he handled.

Focusing on the SOP. I’m not sure what version of the SOP the old officer was following. It took some sleuthing and laser-like focus with my magnifying glass to find what the current SOP says about liens on residences:

Lenders must use commercially reasonable and prudent practices to identify collateral, which conforms to procedures at least as thorough as those used for their similarly-sized non-SBA guaranteed commercial loans. (SOP 50 10 6 Part 2, Section B. Chapter 1, 3. a. pg. 256)

  1. If the SBA loan will refinance existing debt, it must be secured with at least the same collateral and lien priority as the debt being refinanced.
  2. If by SBA standards the loan will be over collateralized the lender may approve the release of excess collateral as long as the SBA loan remains “fully secured,” i.e., the combined Net Book Value as adjusted to SBA percentages is equal to the loan amount.

If there is a collateral shortfall, a lien must be taken on the personal residence unless the equity in the real estate is less than 25% of the property’s fair market value. The lender has to provide some documentation to show the equity is less than 25% and no, the stated value on the PFS is not going to cut it, (SOP 50 10 6 Part 2, Section B. Chapter 1, 3. c. iii. pg. 258)

  • But remember: SBA requires an appraisal only on commercial property. The SOP does not require residential appraisals.

Case Solved. In this case the borrower (not the principal) owns a single family home. But that in itself doesn’t mean it has to be pledged collateral. The lender is not prohibited by SBA regs from taking it, but the lender is not required to do so. The only time the lender must take the house as collateral is if the value less senior encumbering liens is greater than 25% of the value of the house.

If there isn’t 25% equity even though the remaining available collateral is insufficient to fully secure loan, as long as all other factors, including repayment ability are strong, SBA will not decline the loan

MYSTERY #2. There’s another issue here. Can the house be listed for sale with a lien securing the commercial loan? The SOP requires the lender to consider the impact that lien recordings may have on its value and marketability (SOP 50 10 6 Part 2, Section B. Chapter 1, 3. c. ii. pg. 257).

Commercial liens are often larger than the value of the residence. That’s why SBA allows the lien to be limited to the amount necessary to ensure the loan is fully secured. But SBA does not prohibit putting a lien on a house listed for sale. Now, the disclaimer: I am not an attorney and I do not offer legal advice. Just an SOP detective, after all.

Richard Jeffrey
Senior Associate, CDC/504 Program
Head Underwriter