The headline rate is not the real risk
If you sign a loan contract based on the rate, the monthly repayment and a verbal summary, you are betting your house, business cash flow or security property on the wrong part of the document. The expensive surprises usually sit in three clauses most borrowers barely read: default interest, review events and indemnities.
I have spent more than 20 years around commercial finance, capital raising and disputes, and I can say this plainly: many borrowers do not get trapped by fraud. They get trapped by documents they technically agreed to but did not properly test. That is exactly why I tell people to get a second opinion before they sign.
If you want the broader framework behind that view, Shane St Reynolds has set it out in Get a Second Opinion Before You Sign. If you want practical books you can actually use, the quickest place to start is the Amazon author store.
Clause one: default interest is often worse than people think
Borrowers usually ask, "What is the rate?" The better question is, "What is the default rate, when does it start, and what counts as default?"
In many loan documents, default interest does not only apply when you miss a monthly repayment. It can also apply after breach of a financial covenant, failure to provide information on time, a loan-to-value ratio breach after revaluation, an unauthorised change in directors or trustees, or another event the lender defines as default.
That matters because default interest is commonly drafted as an additional margin on top of the ordinary rate. The practical effect can be brutal:
- higher monthly interest immediately;
- capitalisation of unpaid interest, depending on the document;
- extra enforcement and legal costs added to the debt; and
- pressure to accept a refinance on worse terms just to stop the bleed.
For consumer credit, the National Consumer Credit Protection Act 2009 (Cth) and the National Credit Code matter, and lenders and credit assistance providers also sit under ASIC's regime. For many business and investment facilities, however, borrowers wrongly assume the same protections apply in the same way. They do not. Plenty of commercial borrowers sign documents with wide default machinery and only learn what it means when the relationship sours.
What to check:
- the exact percentage or formula for default interest;
- whether it applies to the overdue amount only or the whole balance;
- whether interest can compound;
- the full definition of "Event of Default" or similar; and
- whether a non-monetary breach triggers the same pricing penalty as non-payment.
Common mistake: people ask for a lower headline rate and never ask for a cap on default interest or a grace period for minor administrative breaches.
Clause two: review events can let the lender reprice or call time
A great many borrowers think a two-year or three-year facility means certainty for two or three years. Often it does not. The real control point is the review clause.
Look for words such as annual review, material adverse change, revaluation, continuing satisfaction, or on demand. Those words can give a lender room to:
- require updated financials;
- reassess serviceability;
- revalue the security property;
- reduce the limit;
- increase pricing or fees; or
- decline to roll the facility over.
The counter-intuitive point is this: a borrower can make every repayment on time and still have a serious problem at review. A flat or falling valuation, a changed industry risk view, a director dispute, tax arrears, or weaker trading can trigger renegotiation even if no instalment has been missed.
That is why relying on a broker's email summary is not enough. Ask for the facility letter, the general terms and conditions, every security document, and any guarantee and indemnity. Review rights are often spread across all of them.
Questions to ask before you sign:
- Is the facility committed or on demand?
- What specific information must I provide, and by when?
- Can the lender revalue security at my cost?
- What financial covenants apply?
- What happens if a covenant is breached but repayments are up to date?
- Is there a review date, and what happens at that date if the lender is not satisfied?
If the answers are vague, the risk is real.
Clause three: broad indemnities can make you pay more than you expect
Most people treat an indemnity as legal boilerplate. It is not. It is one of the sharpest clauses in the document.
An indemnity can require you to reimburse the lender for losses, costs, taxes, break costs, enforcement expenses and third-party claims in circumstances that go well beyond ordinary repayment. It may also sit beside a guarantee, which means a director, spouse, trustee or related entity may be taking on exposure more extensive than they realise.
In secured lending, you should check whether the indemnity covers:
- all costs on a full indemnity basis;
- costs before court proceedings start;
- costs of preserving, insuring or selling security;
- break costs if you repay early; and
- liabilities arising from invalidity of another part of the arrangement.
This is where people often get careless with family guarantees. They assume the guarantor is merely "backing" the loan. In reality, the guarantor may be giving a principal obligation and indemnity that survives disputes about the underlying debt. That needs proper reading, not optimism.
A five-part contract check you can use this week
Before signing any loan or refinance, use this short test. It will catch a lot of trouble early.
- Get the whole pack. Ask for the facility letter, standard terms, mortgage or general security agreement, guarantee and indemnity, direct debit form, fee schedule, and any variation letter. Do not review a summary only.
- Mark every trigger. Highlight every clause using words like default, review, adverse change, valuation, demand, cost, indemnity, break cost, representation and covenant.
- Write a one-page risk sheet. In plain English, note what could increase your rate, reduce your limit, require more security, or let the lender enforce. If you cannot explain the trigger in one sentence, you do not yet understand it.
- Send three written questions. Email the lender or broker: "Please confirm in writing when default interest can apply, what review rights may alter pricing or limits, and the scope of any indemnity or break costs." Keep the reply.
- Get a second pair of eyes. For commercial or mixed-purpose lending, have a solicitor or an experienced independent adviser review the documents before you sign, not after the relationship goes bad.
Copy-and-send wording:
Please provide the complete contractual documents for review, including all standard terms, securities and guarantees. Please also confirm in writing: (1) all circumstances in which default interest may apply, (2) all review events that may allow repricing, revaluation, limit reduction or non-renewal, and (3) the full scope of any indemnity, break costs and enforcement costs.
What regulators can and cannot do for you
People also get this wrong: they assume a regulator will fix a bad finance decision. Sometimes there is help; often there are limits.
If the matter involves consumer credit or credit assistance, ASIC is the main regulator federally, and many lenders and brokers belong to the Australian Financial Complaints Authority (AFCA). AFCA can be important for eligible disputes, but it is not a substitute for reading before signing. For purely commercial lending, rights and forum options may be narrower and much more document-driven.
If a broker holds an Australian Credit Licence or acts as a credit representative in a regulated credit context, ask for their licence details and their internal dispute resolution process. If the loan is for business purposes, ask a different question: "What part of this transaction is unregulated, and what protections do not apply to me here?" Many borrowers never ask that at all.
For commentary on law, justice and public policy issues that affect ordinary Australians, see shanereynolds.com.au. For commercial finance and capital structuring work, Poseidon Finance is the relevant site.
The blunt rule: if a clause can move the price, move the property, or move the risk to your family, slow down
The fastest way to make a costly finance mistake is to act embarrassed about asking basic questions. Do not be.
If a lender can increase your effective cost after a technical breach, force a review because a valuation changes, or recover broad costs under an indemnity, those are not minor legal details. They are commercial terms. Treat them with the same seriousness as the rate.
This article is general information, not legal or financial advice.
Before you sign anything, get the books and get proper advice
Start with the books here: Amazon · Shane St Reynolds.
If you want a second opinion on a loan, guarantee, security package, dispute or finance structure, book a consultation at shanestreynolds.com/contact.
You can also email [email protected] or call 08 6263 6236.