Protective advances: Overview, definition, and example
What are protective advances?
Protective advances refer to funds that a lender or creditor provides to a borrower in order to protect the lender's interest in a loan or collateral. These advances are typically made when the borrower is unable or unwilling to meet specific obligations under the terms of a loan agreement, such as maintaining insurance, paying property taxes, or repairing collateral. The lender may make these advances to safeguard the value of the collateral or to prevent the borrower from defaulting on the loan, ensuring that the lender’s investment is protected.
In simpler terms, protective advances are extra funds a lender provides to maintain or protect the assets securing a loan, usually to prevent a default or loss in the value of collateral.
Why are protective advances important?
Protective advances are important because they allow lenders to take proactive steps to safeguard their investment and prevent the risk of collateral devaluation or loss. These advances help ensure that the borrower is meeting the necessary obligations that protect both the lender and the loan’s collateral. Without protective advances, a lender’s collateral could be compromised, increasing the risk of financial loss and potential legal disputes.
For borrowers, protective advances can help avoid default or foreclosure by ensuring that the loan remains secure, but they often come with the added cost of the funds advanced, which may need to be reimbursed or added to the loan balance.
Understanding protective advances through an example
Imagine a borrower takes out a mortgage to purchase a home. As part of the loan agreement, the borrower is required to maintain homeowner's insurance. If the borrower fails to pay for the insurance, the lender may provide a protective advance to cover the cost of the insurance policy in order to protect the value of the home (the collateral). The borrower is then responsible for repaying the lender for this advance.
In another example, a business owner takes out a loan and provides a factory as collateral. If the business owner fails to pay the property taxes, the lender may make a protective advance to pay the taxes and avoid a lien being placed on the property. This ensures that the value of the factory, and thus the collateral securing the loan, remains intact.
Example of a protective advances clause
Here’s how a protective advances clause might appear in a loan agreement:
"The Lender may, at its discretion, make protective advances on behalf of the Borrower to ensure that the value of the Collateral is maintained, including but not limited to paying property taxes, insurance premiums, or costs related to the maintenance of the Collateral. Any protective advances made by the Lender shall be added to the outstanding loan balance and shall bear interest at the rate specified in this Agreement. The Borrower agrees to repay all protective advances upon demand by the Lender."
Conclusion
Protective advances are an important tool for lenders to mitigate risk and ensure the integrity of collateral throughout the life of a loan. By making these advances, lenders protect their financial interests and help prevent potential losses. For borrowers, while protective advances can provide a way to avoid default, they come with additional financial obligations that must be repaid.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.