An assignment of rents is added security for a lender when you use an investment property as collateral for your small business loan. For example, if you own a two-story building with your business on the first floor and an apartment on the second, a portion of the loan's repayment is based on the income from the rental portion. Knowing this, the lender files the assignment of leases and rents along with the mortgage. This document allows the lender to collect rent directly from your tenant in the event you fail to repay the loan.
Absolute vs. Conditional
The lender's ability to collect the rents is dependent on the type of assignment filed. An absolute assignment of leases and rents gives the lender complete control, transferring all interest in the lease and rent collection from the borrower. A conditional assignment places a lien on the rents and allows the lender to collect the funds by taking possession of the property. This occurs either by the lender or a court-appointed receiver depending on state law and is regardless of the size of the small business loan.
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The ability to enforce an assignment of rents on a small business loan starts upfront. The assignment of rents document must be accurate, fully executed and properly recorded. The document itself has to reference the right promissory note and contain a full legal description of the property. The document must be signed by the owners of the property, witnessed and notarized. Finally, it must be sent to the proper county for recording with proof of clear title so no other mortgage company has first rights to the rents. If any of these elements is incorrect, it will be much more difficult to collect the rents if the small business loan goes into default.
Even with proper documentation and recording, the lender can't collect the rents until the small business loan is in default. There are a number of events of default that can occur, but the most common is non-payment of the loan. When a loan has gone between 60 and 90 days without a payment, the lender sends a default letter to the borrower giving him a limited period of time to bring the loan current. If this does not occur, the lender can then proceed with action against the borrower, including enforcing the assignment of rents.
After a default is declared and the borrower fails to bring the small business loan current, the lender will send notice to the tenant. The notice informs the tenant that all rents are to be forwarded to the lender immediately. The only thing that changes for the tenant is the address and the payee. The rent check is made directly to the mortgage company who applies it to a specially designated expense account upon receipt. This process continues until the lease expires, the property is sold, or the borrower corrects the default.