The Difference Between Loan Defaults and Arrears

The Difference Between Loan Defaults and Arrears

When using financial terms in relation to crowdfunding, a relatively recent subcategory of alternative investment, there can be some confusion. On Max Crowdfund, loans are requested by developers in different countries, with communications taking place in both Dutch and English (and sometimes translated from German) making confusion even more likely. This article sets out to distinguish between the different types of delays that can apply to a property loan, the different words used in connection to them, and finally a mention of the Max Crowdfund loan terms as a response to these respective scenarios.  

Defaults vs. Arrears 

These two words are often used interchangeably, and the distinction between them is subtle. Moreover, these words can mean slightly different things depending on context. In the case of property loans, specifically real estate loans on the Max Crowdfund platform, this is how we choose to define these terms:  

default on a loan occurs when payments are missed for a specified period of time and it has been established that the loan is no longer going to be repaid. Arrears, in comparison, are payments that are late, delayed or missed but where the developer has every intention of making the payments at a later date. In the case of a default, the loan terms have been broken and the property will have to be sold in order to reclaim the investors’ money. Essentially, the deal has failed. In the case of arrears, or delays, the deal has not fallen through, but the timeline has been adjusted.  

These two scenarios are similar semantically but hugely different in practical terms; in the case of delays or arrears, the investors are expected to receive their initial capital plus their promised interest from the developer as originally planned, the only difference is the timing. In the case of a default, the developer is unable to deliver the original exit strategy and a debt collection process has to be applied.  

Max Crowdfund Loan Terms

On the Max Crowdfund platform, developers are held to a set of loan terms in order to protect the investors participating in those loans. These were adjusted in late 2022 in order to further protect investors from delays currently affecting the post-COVID construction industry.  

(Note: Project Owners are borrowers, project developers, developers etc.  Basically, they are the company borrowing the money and doing the construction work)

In the case of loan repayments not being made via the Max Crowdfund platform, Project Owners have 60 days before the property is realised as a security. Before this happens, there are no less than 12 steps that the Max Crowdfund debt collection department takes, which include different methods of contacting the developer as well as sending four registered letters. If a payment has been missed beyond the due date, a Project Owner will immediately incur fines and extrajudicial collection costs - except under circumstances where the Project Owner has been exempt from these by making a request in accordance with article 19.5 of the MCF Terms and Conditions.  

Examples of Project Defaults/Arrears  

In the case of a delay in the repayment of the interest or loan capital between a Project Owner (borrower) and an investor (lender), Max Crowdfund will try to mediate a solution that best meets the interests of both parties. There is a voting system in place that puts the decision firmly in the hands of the investors in any project. Max Crowdfund staff will merely present the options and facilitate communications between the two parties.  

Consider this (fictional) example:  A developer has purchased land for the construction of a new house. However, his architect has fallen ill and due to shipping delays, he is unable to get delivery of the wood he has purchased for construction. The whole project is delayed by six months. There are now two options available to investors in the project; sell the half-built house and take the money, or let the developer finish the project and wait an extra six months.   

The foreclosure of a property that is not completed may not be in the best interest of either the developer or the investor; selling the incomplete property under fire sale conditions holds a higher risk of not being able to cover the loan amount. In this scenario, the investor may lose a portion of their capital.  

If the investors choose to keep the developer in arears but not default, however, the developer would be allowed to complete the project and achieve the completed value for the property. The investor would have to wait, but would at least receive the full capital and interest at a later date.  

In a different (also fictional) example, the reverse may be true; A developer has purchased a tenanted block of apartments and is seeking planning permission for the construction of an additional floor. Three months into the project, the planning permission has not been granted, delaying the process by an unknown amount of time.  

In this case, selling the apartment block may be a better option for investors, as the capital of the loan could be reclaimed by the property sale, and waiting for planning permission could take years if not initially granted. In this case, taking the loan amount back and not waiting might be the favourite choice- again, the choice is completely down to the investors in the project. 

Project Delays 

The global real estate industry has unfortunately been experiencing setbacks in shipping, materials and labour and this has affected the entire sector. Some projects on Max Crowdfund have also been suffering the effects of this, and the debt collection department has had to become engaged in the loan delay procedure in some cases. We urge any investors affected by construction delays to place close attention to communications and to participate in the voting procedures. For more info on global industry delays, please click here.  

Please note, Max Crowdfund is an intermediary platform. Max Crowdfund does not give investment advice, does not make investment decisions or get involved in the development of real estate projects, we merely put together borrowers and lenders and we try to help if things go wrong between the two parties. For more information on how the voting system works on Max Crowdfund, please click here.