Default clauses and default interest

Why default clauses matter

Borrowers naturally focus on the amount, the cost and the speed of a loan. The default clause gets less attention because nobody plans to default. But default clauses decide what happens when things do not go to plan, and in short-term private lending, plans can slip. A sale takes longer, a refinance is delayed or another creditor takes action. Understanding the default terms before you sign can save a great deal of money and stress later.

What counts as a default

Default clauses are usually broader than people expect. Common default events include:

• Non-payment. Missing an interest payment or failing to repay at maturity.
• Breach of other terms. Not maintaining insurance, letting council rates or strata levies fall into arrears, or failing to provide information when asked.
• Misrepresentation. Information in the application turning out to be false or misleading.
• Insolvency events. The borrower or a guarantor becoming insolvent, a liquidator or administrator being appointed, or a winding-up application being filed.
• Other creditor action. A judgment, writ or statutory demand against the borrower, or another lender declaring a default.
• Change of control. A change in company directors or shareholders without the lender’s consent.
• Dealing with the property. Selling, leasing or further mortgaging the property without consent.
• Material adverse change. Some documents include a general clause covering significant deterioration in the borrower’s position.

Default interest

Many private loans specify a default interest charge that applies on top of, or instead of, the standard charge once the loan is in default. It is typically calculated on the whole outstanding balance from the date of default until the default is remedied. Even a few weeks can add up on a large loan. Check how it is calculated, when it starts and when it stops.

Fees and enforcement costs

Beyond default interest, loan documents usually allow the lender to recover its costs of dealing with the default. These can include legal fees, valuation fees, agent and auction costs if the property is sold, and the lender’s internal administration fees. These costs are typically added to the debt and recovered from the sale proceeds or from the borrower and guarantors.

Notice and cure periods

Some defaults require the lender to give written notice and allow a set period for the borrower to fix the problem, known as a cure period. Others, such as an insolvency event, may allow immediate action. For residential property, statutory notice requirements may apply in some circumstances, but business loans are generally governed by the contract terms. Your solicitor should explain exactly what notice you would receive.

What lenders do after default

Lenders generally prefer repayment to enforcement, which is slow, costly and uncertain for them too. Typical steps after a default include:

1. Contacting the borrower to understand the problem.
2. Issuing a formal default notice.
3. Negotiating a resolution, such as an extension or partial repayment.
4. If unresolved, taking possession of the property and selling it as mortgagee.

Our guide to mortgagee sales explains that final stage and how to avoid it.

Reading the clause before you sign

Ask your solicitor to walk you through the default section of the documents. Questions to raise include: Which events are defaults? Which have cure periods and how long are they? How is default interest calculated? Are there fees for default notices? Does a default on another loan count? Can any triggers be narrowed? Our checklist of questions to ask before signing covers these and more.

Staying out of default

The simplest protection is planning. Choose a term with a buffer, keep insurance and rates current, respond promptly to lender requests and monitor your exit closely. If another creditor threatens action, tell your lender before it escalates. Many defaults that turn into disputes began as small problems the borrower hoped would go away.

If default is coming

If you can see you will miss a payment or maturity, contact the lender as early as possible. Explain what has happened, what you are doing about it and when you expect to resolve it. Offer evidence, such as an updated sale campaign or refinance approval. Ask whether an extension or variation is possible before the default occurs. Lenders are more flexible with borrowers who are open and proactive.

If the existing lender will not help, refinancing to another lender may be possible. See our page on an expiring private loan.

Illustrative example

A borrower’s refinance is delayed when the bank asks for updated financial statements. The private loan is due in three weeks. She contacts the private lender immediately, provides the bank’s conditional approval and asks for a six-week extension. The lender agrees for a fee. Without the early call, the loan would have gone into default at maturity, triggering default interest on the full balance for the weeks until the bank refinance settled.

This example is illustrative only.

Getting started

If you are planning a secured loan and want to understand typical terms, or your current loan is heading towards default, check your eligibility with no credit check. We will look at the scenario and explain the options plainly.

Start your enquiry today.