Summary: Real-life example

The owner holds the title to the building as trustee of a family trust, a legal arrangement that allows a trustee to own assets on behalf of a beneficiary. The owner operates an ongoing retail business, holding title in an S-corporation, a type of corporation considered a pass-through entity for income tax purposes. The income is taxed at individual rates.

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As a fiduciary of the borrower, the mortgage broker acts as a trusted intermediary between the borrower and the lender. They assist borrowers in navigating the complex mortgage process and provide expert advice. They also ensure that the borrower's best interests are always at the forefront of their actions, making you feel valued and prioritized.

The mortgage broker, a seasoned professional with extensive knowledge and experience in the field, provided the following advice:

I have a client who is a dentist providing dental services to low-income and credit-based customers. He operates his dental practice as an S corporation and is based in a building he owns through a revocable family trust. Can he get a loan?

The experienced lender provided a detailed response to the client's query, shedding light on the underwriting procedure:

Yes, however, the underwriting procedure is different. During the appraisal process, the appraiser will determine whether the rent paid by one entity to another is considered market rent. The valuation would rely on comparable commercial rents in the geographic area rather than what he is paying himself. This means that the borrower's ability to pay will be assessed based on the property's market value, not just the rent he charges.

Part of the appraisal process is a rent survey. The appraiser will determine whether the rent is above, at, or below market. Since his S-corporation is a pass-through entity, all profits will pass through to his tax returns. The lender will underwrite the ability to pay by reviewing the borrower's and his corporation's income.

Since the property's title is held in a revocable family trust, a legal arrangement that allows the owner to retain control over the property and make changes to the trust, it is customary for the owner to be required to sign a personal guarantee. This means that the owner is personally liable for the loan, even though the trust owns the property. If the lender successfully forecloses on the property and fails to recover the amount due, including principal, interest, and costs, the lender may sue the owner personally for any deficiency.

Lastly, if the subject loan is a second trust deed junior to a first, the loan is a secondary mortgage on the property with another mortgage already in place. In this case, the business entity may need to sign a subordination agreement to ensure it is junior to the recorded deed of trust. A subordination agreement is a legal document that changes the priority of the mortgage, making the new mortgage (the second trust deed) junior to the existing one. If the lender were to foreclose on the property ownership entity, meaning the family trust, the lender would not want to keep the S-corporation tenancy of a related defaulted party.

In their unwavering commitment to your security, the lender will meticulously review the first lien loan documents to ensure there is no alienation clause or due-on-further encumbrance clause that would prohibit the lender from recording a junior lien, providing you with a sense of security and peace of mind.