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Mortgage Loan Warehousing Agreement - NovaStar Mortgage Inc. and First Union National Bank of North Carolina

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                       MORTGAGE LOAN WAREHOUSING AGREEMENT
                       -----------------------------------


         THIS MORTGAGE LOAN WAREHOUSING AGREEMENT (the "Agreement") is made as
of the _____ day of February, 1997, by and between NOVASTAR MORTGAGE, INC., a
Virginia corporation (the "Company") and FIRST UNION NATIONAL BANK OF NORTH
CAROLINA, a national banking corporation (the "Lender").

                              STATEMENT OF PURPOSE
                              --------------------

         The Company has requested the Lender to extend to the Company a
mortgage warehousing line of credit to fund the Company's purchase and
accumulation of single-family residential mortgage loans for sale to secondary
market investors or for securitization purposes, and the Lender has agreed to do
so on the terms and subject to the conditions set forth herein. All capitalized
terms not otherwise defined herein are defined in Paragraph 10 hereof.

         Now, therefore, for good and valuable consideration, the receipt and
adequacy of which are hereby acknowledged, the parties hereto agree as follows:

                                    AGREEMENT
                                    ---------

         1.       Credit Facility.
                  ---------------

                  1(a)     Lending Limit.  Subject to the conditions set forth 
                           -------------
herein, the Lender agrees that it shall from time to time up to and including 
the Business Day immediately preceding the Maturity Date, advance loans (the 
"Loans" or a "Loan") to the Company in amounts not to exceed, in the aggregate 
at any one time outstanding (determined after giving effect to the other 
transactions contemplated by the Loan Request pursuant to which said Loan was 
requested), the lesser of:

                           (1)      The Credit Limit; and

                           (2)      The Collateral Value of the Borrowing Base.

                  1(b) Interest Rate. Loans shall bear interest at a rate equal
                       -------------
to the Applicable Fed-Funds Based Rate unless the Company elects to have a Loan
bear interest at the Applicable LIBOR-Based Rate as permitted herein.


                  1(c) Payment of Interest. The Company shall pay to the Lender
                       -------------------
interest on Loans outstanding hereunder from the date disbursed to but not
including the date of payment. Interest on Fed Funds Loans shall be payable
monthly, in arrears, as provided in Paragraph 2(d) below, and interest on
Eurodollar Loans shall be payable at the end of the applicable Interest Period
and, in the event the applicable Interest Period exceeds one month, monthly in
arrears, as provided in Paragraph 2(d) below.
<PAGE>
 
                  1(d)     Conversion and Continuation.
                           ---------------------------

                           (1) The Company may elect from time to time to
         convert Eurodollar Loans to Fed Funds Loans by giving the Lender at
         least one Business Day's prior irrevocable notice of such election. Any
         conversion of Eurodollar Loans may only be made on the last day of the
         applicable Interest Period. Subject to the limitation set forth in the
         last sentence of Paragraph 2(b)(2) hereof, the Company may elect from
         time to time to convert Fed Funds Loans to Eurodollar Loans by giving
         the Lender at least three Eurodollar Business Days' prior irrevocable
         notice of such election. All such elections shall be made by means of a
         Loan Request. No Fed Funds Loan shall be converted into a Eurodollar
         Loan if an Event of Default or Potential Default has occurred and is
         continuing on the day occurring three Eurodollar Business Days prior to
         the date of the conversion requested by the Company or on the date of
         conversion. All or any part of outstanding Loans may be converted as
         provided herein, provided that partial conversions shall be in a
         principal amount of $1,000,000.00 or whole multiples of $100,000.00 in
         excess thereof.

                           (2) Any Eurodollar Loan may be continued as such upon
         the expiration of the Interest Period with respect thereto by the
         Company giving the Lender at least three Eurodollar Business Days'
         prior irrevocable notice of such election as set forth in a Loan
         Request; provided, however, that no Eurodollar Loan may be continued as
         such when any Event of Default or Potential Default has occurred and is
         continuing on the day occurring three Eurodollar Business Days prior to
         the proposed date of such continuation or on the date of conversion,
         but shall be automatically converted to a Fed Funds Rate Loan on the
         last day of the then current Interest Period applicable thereto, and
         the Lender shall notify the Company promptly that such automatic
         conversion will occur. If the Company shall fail to give notice as
         provided above, the Company shall be deemed to have elected to convert
         the affected Eurodollar Loan to a Fed Funds Loan on the last day of the
         relevant Interest Period.

                  1(e) Inability to Determine Rate. If the Lender determines
                       ---------------------------
(which determination shall be conclusive and binding upon the Company) that by
reason of circumstances affecting the London interbank eurodollar market
adequate and reasonable means do not exist for ascertaining the LIBOR Rate for
any Interest Period, the Lender shall forthwith give facsimile notice of such
determination, confirmed in writing, to the Company. If such notice is given:
(1) no Loan may be funded as a Eurodollar Loan, (2) any Loan that was to have
been converted to a Eurodollar Loan 

                                       2
<PAGE>
 
shall, subject to the provisions hereof, be continued as a Fed Funds Loan and
(3) any outstanding Eurodollar Loan shall be converted on the last day of the
then current Interest Period with respect thereto to a Fed Funds Loan. Until
such notice has been withdrawn by the Lender, the Company shall not have the
right to convert a Loan to a Eurodollar Loan or fund any Loan as a Eurodollar
Loan or to continue a Eurodollar Loan as such. The Lender shall withdraw such
notice in the event that the circumstances giving rise thereto no longer obtain
and that adequate and reasonable means exist for ascertaining the LIBOR Rate for
the Interest Period requested by the Company, and following withdrawal of such
notice by the Lender, the Company shall have the right to fund any Loan as a
Eurodollar Loan or convert a Loan to a Eurodollar Loan or to continue a
Eurodollar Loan in accordance with the terms and conditions of this Agreement.

                  1(f) Illegality. Notwithstanding any other provisions herein,
                       ----------
if any law, regulation, treaty or directive or any change therein or in the
interpretation or application thereof, shall make it unlawful for the Lender to
make or maintain Eurodollar Loans as contemplated by this Agreement: (1) the
commitment of the Lender hereunder to continue Eurodollar Loans or to convert
Fed Funds Loans to Eurodollar Loans shall forthwith be canceled and (2) all
Loans then outstanding as Eurodollar Loans, if any, shall be converted
automatically to Fed Funds Loans at the end of their respective Interest Periods
or within such earlier period as required by law. In the event of a conversion
of any such Loan prior to the end of its applicable Interest Period the Company
hereby agrees promptly to pay the Lender, upon demand, the amounts required
pursuant to Paragraph 1(i) below, it being agreed and understood that such
conversion shall constitute a prepayment for all purposes hereof. The provisions
hereof shall survive the termination of this Agreement and payment of the
outstanding Loans and all other amounts payable hereunder.

                  1(g) Requirements of Law; Increased Costs. In the event that
                       ------------------------------------
any change subsequent to the date hereof in any applicable law, order,
regulation, treaty or directive issued by any central bank or other Governmental
Authority, or in the governmental or judicial interpretation or application
thereof, or compliance by the Lender with any request or directive (whether or
not having the force of law) by any central bank or other Governmental
Authority:

                       (1) subjects the Lender to any tax of any kind whatsoever
     with respect to this Agreement or any Loans made hereunder, or change the
     basis of taxation of payments to the Lender of principal, fee, interest or
     any other amount payable hereunder (except for change in the rate of tax on
     the overall net income of the Lender);

                                       3
<PAGE>
 
                       (2) imposes, modifies or holds applicable any reserve,
     capital requirement, special deposit, compulsory loan or similar
     requirements against assets held by, or deposits or other liabilities in or
     for the account of, advances or loans by, or other credit extended by, or
     any other acquisition of funds by, any office of the Lender which are not
     otherwise included in the determination of the Fed Funds Rate or the LIBOR
     Rate; or

                       (3) imposes on the Lender any other condition;

and the result of any of the foregoing is to increase the cost to the Lender of
making, renewing or maintaining any Loan or to reduce any amount receivable in
respect thereof or to reduce the rate of return on the capital of the Lender or
any Person controlling the Lender, then, in any such case, the Company shall
promptly pay to the Lender, upon its written demand, any additional amounts
necessary to compensate the Lender for such additional cost or reduced amounts
receivable or rate of return as determined by the Lender with respect to this
Agreement or Loans made hereunder. If the Lender becomes entitled to claim any
additional amounts pursuant to this Paragraph 1(g), it shall promptly notify the
Company of the event by reason of which it has become so entitled. A certificate
as to any additional amounts payable pursuant to the foregoing sentence
containing the calculation thereof in reasonable detail submitted by the Lender
to the Company shall be conclusive in the absence of manifest error.
The provisions hereof shall survive the termination of this Agreement and
payment of the outstanding Loans and all other amounts payable hereunder.

                  1(h) Funding. The Lender shall be entitled to fund all or any
                       -------
portion of the Loans in any manner it may determine in its sole discretion, but
all calculations and transactions hereunder shall be conducted as though the
Lender actually funds all Eurodollar Loans through the purchase in London of
offshore dollar deposits in the amount of the relevant Eurodollar Loan in
maturities corresponding to the applicable Interest Period.

                  1(i) Funding Indemnification -- Prepayment. In addition to all
                       -------------------------------------
other payment obligations hereunder, in the event any Loan which is outstanding
as a Eurodollar Loan is prepaid prior to the last day of the applicable Interest
Period, whether following a voluntary prepayment or a mandatory prepayment,
notwithstanding that the Loan may have borne interest at the Eurodollar Rate,
such Loan shall be deemed to have borne interest as though it were a Fed Funds
Loan from the first day of the applicable Interest Period through the date of
such prepayment and the Company shall immediately pay to the Lender interest at
the 

                                       4
<PAGE>
 
Applicable Fed Funds-Based Rate for such period, and shall also immediately
pay to the Lender an additional amount compensating the Lender for losses and
expenses incurred by the Lender in connection with such prepayment, including,
without limitation, such as may arise out of a re-employment of funds obtained
by the Lender and from fees payable to terminate the deposits from which such
funds were obtained, such losses, and expenses and the method of calculation
thereof being set forth in reasonable detail and a statement delivered to the
Company by the Lender. Under no circumstances shall the Lender have any
obligation to remit monies to the Company upon prepayment of any Eurodollar Loan
even under circumstances which do not result in the necessity of the payment by
the Company of any amount hereunder. The provisions hereof shall survive
termination of this Agreement and payment of the outstanding Loans and all
amounts payable hereunder.

                  1(j) Funding Indemnification -- Default or Failure to Continue
                       ---------------------------------------------------------
or Convert. In addition to all other payment obligations hereunder, in the event
----------
the Company shall fail to continue or to make a conversion to a Eurodollar Loan
after the Company has given notice thereof as provided in Paragraph 1(d) above,
or if after giving a notice to have the Lender make a Eurodollar Loan, the
Lender is not obligated to do so due to the existence of an Event of Default or
Potential Default, then the Company shall immediately pay to the Lender an
additional amount compensating the Lender for losses and expenses incurred by
the Lender in connection with such failure to continue or convert a Eurodollar
Loan, or the occurrence of an Event of Default or Potential Default including,
without limitation, such as may arise out of re-employment of funds obtained by
the Lender and from fees payable to terminate the deposits from which such funds
were obtained, such losses and expenses and the method of calcula tion thereof
being set forth in reasonable detail in a statement delivered to the Company by
the Lender. The provisions hereof shall survive termination of this Agreement
and payment of the outstanding Loans and all other amounts payable hereunder.

         2.       Miscellaneous Lending Provisions.
                  --------------------------------

                  2(a) Use of Proceeds. The proceeds of all Loans shall be used
                       ---------------
by the Company solely for the purpose of originating and acquiring Mortgage
Loans or acquiring Mortgage-Backed Securities.

                  2(b) Request For Loans; Making of Loans.
                       ----------------------------------     

                       (1) If the Company desires to borrow a Fed Funds Loan
         hereunder, the Company shall make a Loan Request to the Lender no later
         than 2:00 p.m. (Charlotte, North Carolina time) on the proposed funding
         date. The Lender shall make available the proposed Loan by crediting
         the amount thereof 

                                       5
<PAGE>
 
         in immediately available same day funds to the Funding Account no later
         than 3:30 p.m. (Charlotte, North Carolina time) on such date.

                       (2) If the Company desires to borrow or continue a
         Eurodollar Loan or to convert a Fed Funds Loan to a Eurodollar Loan as
         provided in Paragraph 1(d) above, the Company shall make a Loan Request
         to the Lender no later than 2:00 p.m. (Charlotte, North Carolina time)
         on the day occurring at least three Eurodollar Business Days prior to
         the date of the borrowing, conversion or continuation requested
         therein. Notwithstanding any provision hereof to the contrary, the
         parties agree that the Company may have only four (4) outstanding
         Eurodollar Loans at any time and that each Eurodollar Loan shall be in
         a principal amount of $1,000,000.00 or whole multiples of $100,000.00
         in excess thereof.

                  2(c) Notes. The obligation of the Company to repay the Loans
                       -----
shall be evidenced by a note payable to the order of the Lender in the form
attached hereto as Exhibit A (the "Note").
                   ---------
  
                  2(d) Interest and Fee Billing and Payment. The Lender shall
                       ------------------------------------ 
(1) in the case of Fed Funds Loans and Eurodollar Loans having an Interest
Period in excess of one month, on or before the fifth Business Day of each
month, and (2) in the case of Eurodollar Loans, also on the last day of the
applicable Interest Period, deliver to the Company an interest and fee billing
for the immediately preceding month or Interest Period, as the case may be,
which billing shall set forth interest accrued and payable on Loans and fees
payable hereunder for such period and which billing shall be payable, in the
case of a billing delivered pursuant to subparagraph (1) above, no later than
the second Business Day following receipt thereof by the Company and, in the
case of a billing delivered pursuant to subparagraph (2) above, on the last day
of the applicable Interest Period.

                  2(e) Repayment of Principal. Subject to the prepayment
                       ----------------------
requirements of Paragraph 2(j) below and the required application of proceeds
from the sale or other disposition of Mortgage Loans as provided in the Security
Agreement, the Company shall pay the principal amount of each Eurodollar Loan on
the last day of the applicable Interest Period relating thereto and shall pay
the principal amount of all other Loans on the Maturity Date.

                  2(f) Borrowing Base Conformity.
                       -------------------------
   
          (1) The Company shall cause to be maintained with the Lender a
     Borrowing Base such that the Collateral Value of the Borrowing Base is not
     less than, at any date, the sum of the aggregate dollar amount of
     outstanding Loans.

                                       6
<PAGE>
 
                       (2) The Company shall prepay Loans to the Lender, upon
     telephonic or facsimile demand by the Lender, on any day in the amount by
     which the aggregate principal amount of outstanding Loans exceeds the
     Collateral Value of the Borrowing Base, said prepayment to be made on the
     date on which demand is made by the Lender if made prior to 4:00 p.m.
     (Charlotte, North Carolina time) or, if made later than 4:00 p.m.
     (Charlotte, North Carolina time), before 9:00 a.m. (Charlotte, North
     Carolina time) on the next Business Day.

                       (3) If at such time as the Company shall be required to
     prepay Loans under this Paragraph 2(f) there shall not have occurred and be
     continuing an Event of Default or Potential Default hereunder, in lieu of
     prepaying the Loans as required, the Company may deliver to the Lender
     additional Eligible Mortgage Loans such that the Collateral Value of the
     Borrowing Base, after giving effect to the inclusion of such Eligible
     Mortgage Loans in the Borrowing Base, shall be in compliance with the
     requirements of subparagraphs (1) and (2) above.

                  2(g) Nature and Place of Payments. All payments made on
                       ----------------------------
account of the Obligations shall be made to the Lender and the Lender is hereby
irrevocably authorized to debit the Settlement Account on account thereof. All
payments made on account of the Obligations shall be made without set-off or
counterclaim in lawful money of the United States of America in immediately
available same day funds, free and clear of and without deduction for any taxes,
fees or other charges of any nature whatsoever imposed by any taxing authority
and if received by the Lender by 4:00 p.m. (Charlotte, North Carolina time) such
payment will be credited on the Business Day received. If a payment is received
after 4:00 p.m. (Charlotte, North Carolina time) by the Lender, such payment
will be credited on the next succeeding Business Day and interest thereon shall
be payable at the then applicable rate until credited. If any payment required
to be made by the Company hereunder becomes due and payable on a day other than
a Business Day, the due date thereof shall be extended to the next succeeding
Business Day and interest thereon shall be payable at the then applicable rate
during such extension.

                  2(h) Post-Maturity Interest. Any Obligations not paid when due
                       ---------------------- 
(whether at stated maturity, upon acceleration or otherwise) shall bear interest
from the date due until paid in full at a per annum rate equal to two percent
(2%) above the interest rate otherwise applicable thereto, or, if such
Obligations do not otherwise bear interest, two percent (2%) above the Corporate
Base Rate.

                                       7
<PAGE>
 
             2(i) Computations. All computations of interest and fees payable
                  ------------ 
hereunder shall be based upon a year of 360 days for the actual number of days
elapsed.

             2(j) Prepayments.
                  -----------

                  (1) The Company may voluntarily prepay Loans hereunder
     (including a Eurodollar Loan subject to Paragraph 1(i)) in whole or in part
     at any time.

                  (2) Loans hereunder are subject to mandatory prepayment
     pursuant to Paragraph 2(f) above and, in addition, by application of
     proceeds of the sale or other disposition of Collateral as provided in the
     Security Agreement.

                  (3) The Company shall pay in connection with any prepayment
     hereunder all interest accrued but unpaid on Loans to which such prepayment
     is applied and any amounts payable pursuant to Paragraph 1(i) above
     concurrently with payment to the Lender of any principal amounts.

             2(k) Allocation of Payments Received.
                  -------------------------------

                  (1)  Prior to the occurrence of an Event of Default and
     acceleration of all Loans outstanding hereunder or termination of the
     commitment of the Lender to advance Loans hereunder, all amounts received
     by the Lender shall be applied against the outstanding Obligations.

                  (2)  Following the occurrence of an Event of Default and
     acceleration of all Loans outstanding hereunder or termination of the
     commitments of the Lender to advance Loans hereunder, all amounts received
     by the Lender on account of the Obligations shall be applied by the Lender
     as follows:

                       (i)   First, to the payment of reasonable costs and
     expenses incurred by the Lender in the enforcement of its rights under the
     Credit Documents, including, without limitation, all costs and expenses of
     collection, attorneys' fees, court costs and foreclosure expenses;

                       (ii)  Second, to the Lender to be applied against the
     Obligations until the Obligations shall have been paid in full; and

                       (iii) Third, to such Persons as may be legally entitled
     thereto.

                                       8
<PAGE>
 
                  2(l) Fees. The Company shall pay the following fees to the
                       ----
Lender:

                       (1) Such closing fees as are agreed to in writing by the
Company and the Lender, said fees to be payable on or before the date of making
the first Loan hereunder.

                       (2) A non-refundable non-usage fee, such fee to be
payable in quarterly installments, in arrears, on the last Business Day of each
March, June, September and December during the term of this Agreement, each such
installment to be in an amount equal to the product of: (i) the amount by which
the Credit Limit exceeded the average daily amount of Loans outstanding during
the previous calendar quarter, multiplied by (ii) 0.125%, divided by (iii) 4;
                               ----------                 -------
provided, however, that no non-usage fee shall be owed by the Company to the
--------  -------
Lender under this Paragraph 2(l)(2) for any quarter during which the average
daily amount of Loans outstanding during such calendar quarter equals or exceeds
fifty percent (50%) of the Credit Limit.

                       (3) An aged loan fee, such fee to be payable monthly in
arrears on the applicable dates specified in Paragraph 2(d) hereof, each such
installment to be in an amount equal to the product of (i) the average daily
aggregate principal balance of all Mortgage Loans included in the Borrowing Base
during said month of the type described in the first proviso to subsection (p)
of the definition of "Eligible Mortgage Loan," multiplied by (ii) 0.125%,
                                               ----------
divided by (iii) 12.

                       (4) A collateral handling fee with respect to each
     Mortgage Loan (and related Required Documents) submitted to the Lender for
     inclusion in the Borrowing Base, such fee to be payable monthly in arrears
     on the applicable date specified in Paragraph 2(d) hereof, and to be in the
     amount of (i) for any month during which one hundred (100) or fewer
     Mortgage Loans (and related Required Documents) are delivered to the
     Lender, $10.00 for each Mortgage Loan delivered in such month, and (ii) for
     any month during which more than one hundred (100) Mortgage Loans (and
     related Required Documents) are delivered to the Lender, $7.00 for each
     Mortgage Loan delivered in such month.

         3.       Security Agreement; Guaranties; Additional Documents.
                  ----------------------------------------------------

                  3(a) Security Agreement and Financing Statements. On or before
                       -------------------------------------------
     the date hereof, the Company shall execute and deliver to the Lender: (1) a
     security agreement in the form of that attached hereto as Exhibit B (the
                                                               ---------
     "Security Agreement"), pursuant to which the Company shall pledge, assign
     and grant to the Lender a perfected, first priority security interest in
     and lien upon the Collateral, and (2) such UCC financing statements as the
     Lender 

                                       9
<PAGE>
 
     may request.

                  3(b) Guaranties.
                       ----------

                       (1) On or before the date hereof, the Company shall cause
     to be executed and delivered to the Lender by NovaStar Financial a
     continuing guaranty in the form of that attached hereto as Exhibit C-1 (the
                                                                -----------
     "NovaStar Financial Guaranty").

                       (2) On or before the NFI Holding Delivery Date, the
     Company shall cause to be executed and delivered to the Lender by NFI
     Holding a continuing guaranty in the form of that attached hereto as
     Exhibit C-2 (the "NFI Holding Guaranty" and, together with the NovaStar
     -----------
     Financial Guaranty, the "Guaranties").

                  3(c) Further Documents. The Company agrees to execute and
                       -----------------
deliver and to cause to be executed and delivered to the Lender from time to
time such confirmatory and supplementary security agreements, financing
statements and other documents, instruments and agreements as the Lender may
reasonably request, which are in the Lender's judgment necessary or desirable to
obtain for the Lender the benefit of the Credit Documents and the Collateral.

         4.       Conditions to Making of Loans.
                  -----------------------------

                  4(a) First Loan. As conditions precedent to the Lender's
                       ----------
obligation to make the first Loan hereunder:

                       (1) The Company shall have delivered to the Lender, in
         form and substance satisfactory to the Lender and its counsel, each of
         the following:

                           (i)    A duly executed copy of this Agreement;

                          (ii)    A duly executed copy of the Security Agreement
         and of the NovaStar Financial Guaranty;

                         (iii)    A duly executed copy of the Note;

                          (iv)    Duly executed copies of all financing
         statements and other documents, instruments and agreements, properly
         executed, deemed necessary or appropriate by the Lender, in its
         reasonable discretion, to obtain for the Lender a perfected, first
         priority security interest in and lien upon the Collateral;

                           (v)    Such credit applications, financial 

                                       10
<PAGE>
 
         statements, authorizations and such information concerning the Company
         and its business, operations and conditions (financial and otherwise)
         as the Lender may reasonably request;

                             (vi)  Certified copies of resolutions of the Board
         of Directors of each of the Company and NovaStar Financial approving
         the execution and delivery of the Credit Documents to which the Company
         or NovaStar Financial, as applicable, is a party, the performance of
         the Obligations thereunder and the consummation of the transactions
         contemplated thereby;

                            (vii)  A certificate of the Secretary or an
         Assistant Secretary of each of the Company and NovaStar Financial
         certifying the names and true signatures of the officers of the Company
         or NovaStar Financial, as applicable, authorized to execute and deliver
         the Credit Documents to which the Company or NovaStar Financial, as
         applicable, is a party;

                           (viii)  A copy of the Articles of Incorporation of
         each of the Company and NovaStar Financial, certified by the respective
         Secretary or an Assistant Secretary of the Company or NovaStar
         Financial, as applicable, as of the date of this Agreement as being
         accurate and complete;

                             (ix)  A copy of the Bylaws of each of the Company
         and NovaStar Financial, certified by the respective Secretary or an
         Assistant Secretary of the Company or NovaStar Financial, as
         applicable, as of the date of this Agreement as being accurate and
         complete;

                              (x)  A certificate of the Secretary of State of
         the Commonwealth of Virginia, certifying as of a recent date that the
         Company is in good standing;

                             (xi)  A certificate of the Secretary of State of
         the State of Maryland, certifying as of a recent date that NovaStar
         Financial is in good standing;

                            (xii)  An opinion of counsel for the Company and
         NovaStar Financial substantially in the form of Exhibit D attached
                                                         ---------
         hereto and covering such other matters as the Lender may reasonably
         request;

                           (xiii)  Evidence satisfactory to the Lender that each
         of the Funding Account and the Settlement Account has been opened;

                                       11
<PAGE>
 
                           (xiv)   A schedule of the initial Approved Investors
         duly approved by the Lender;

                            (xv)   A duly completed Borrowing Base Schedule
         dated as of the date of the first Loan hereunder and certified by the
         Company to be true in all respects; and

                           (xvi)   A Covenant Compliance Certificate
         demonstrating in detail satisfactory to the Lender that the Company is
         in compliance with the covenants set forth in Paragraphs 7(h) and 7(i)
         below.

                  (2) All acts and conditions (including, without limitation,
     the obtaining of any necessary regulatory approvals and the making of any
     required filings, recordings or registrations) required to be done and
     performed and to have happened precedent to the execution, delivery and
     performance of the Credit Documents and to constitute the same legal, valid
     and binding obligations, enforceable in accordance with their respective
     terms, shall have been done and performed and shall have happened in due
     and strict compliance with all applicable laws.

                  (3) All documentation, including, without limitation,
     documentation for corporate and legal proceedings in connection with the
     transactions contemplated by the Credit Documents shall be satisfactory in
     form and substance to the Lender and its counsel.

                  (4) All fees required to be paid on or before the date hereof
     pursuant to Paragraph 2(l) above shall have been paid prior to (or will be
     paid concurrently with) the making of the first Loan hereunder.

          4(b)    Ongoing Loans. As conditions precedent to the Lender's
                  -------------
obligation to make any Loan hereunder, including the first Loan and including
the conversion of any Loan to another type of Loan, at and as of the date of
advance, conversion or continuance thereof;

                  (1) There shall have been delivered to the Lender a Loan
     Request therefor;

                  (2) The representations and warranties of the Company
     contained in the Credit Documents shall be accurate and complete in all
     respects as if made on and as of the date of such advance, conversion or
     continuance;

                                       12
<PAGE>
 
                  (3) There shall not have occurred an Event of Default or
     Potential Default;

                  (4) Following the funding of the requested Loan, the aggregate
     principal amount of Loans outstanding will not exceed the lesser of: (i)
     the Credit Limit and (ii) the Collateral Value of the Borrowing Base;

                  (5) There shall not have occurred any material adverse change
     in the financial condition, assets, nature of assets, operations or
     prospects of the Company from that represented in this Agreement, the other
     Credit Documents, or the documents or information furnished to the Lender
     in connection herewith or therewith; and

                  (6) The Required Documents for the Mortgage Loan(s) being
     funded therewith shall have been received by the Lender (except as
     otherwise provided in subsection (o) of the definition of Eligible Mortgage
     Loan).

By making a Loan Request to the Lender hereunder, the Company shall be deemed to
have represented and warranted the accuracy and completeness of the statements
set forth in subparagraphs (b)(2) through (b)(6) above.

          4(c) NFI Holding Documents. Within thirty (30) days from the date of
               ---------------------
this Agreement, the Company shall cause to be delivered to the Lender, in form
and substance satisfactory to the Lender and its counsel, each of the following:

                  (i)   A duly executed copy of the NFI Holding Guaranty;

                  (ii)  Certified copies of resolutions of the Board of
         Directors of NFI Holding approving the execution and delivery of the
         Credit Documents to which NFI Holding is a party, the performance of
         the Obligations thereunder and the communication of the transactions
         contemplated thereby;

                  (iii) A certificate of the Secretary or an Assistant Secretary
         of NFI Holding certifying the names and the signatures of the officers
         of NFI Holding authorized to execute and deliver the Credit Documents
         to which NFI Holding is a party;

                  (iv)  A copy of the Articles of Incorporation of NFI Holding,
         certified by the Secretary or an Assistant Secretary of NFI Holding as
         of the date of this Agreement as being accurate and complete;

                                       13
<PAGE>
 
               (v)   A copy of the Bylaws of NFI Holding, certified by the
          Secretary or an Assistant Secretary of NFI Holding as of the date of
          this Agreement as being accurate and complete;

               (vi)  A certificate of the Secretary of State of ____________,
          certifying as of a recent date that NFI Holding is in good standing;
          and

               (vii)   An opinion of counsel for the Company and the Guarantors
          substantially in the form of Exhibit D attached hereto (as revised to
                                       ---------
          cover both Guarantors) and covering such other matters as the Lender
          may reasonably request. 

     Upon the NFI Holding Delivery Date, NFI Holding shall become a Guarantor
for all purposes under this Agreement.

     5.   Representations and Warranties of the Company.
          ---------------------------------------------

     The Company represents and warrants to the Lender that:

          5(a)  Financial Condition.   The financial statements, dated the
                -------------------
Interim Date, copies of which have been furnished to the Lender, are complete
and correct and have been prepared to present fairly, in accordance with GAAP
(or with such non-GAAP principles as are disclosed to and approved by Lender
from time to time), the financial condition of the Company at such dates and the
results of its operations and changes in financial position for the fiscal
periods then ended.

          5(b)  No Change.   As of the date hereof, there has been no material
                ---------
adverse change in the business, operations, assets or financial or other
condition of the Company from that shown on the financial statements dated as of
the Interim Date referred to in Paragraph 5(a) above.

          5(c)  Corporate Existence; Compliance with Law.   The Company: (1) is
                ----------------------------------------
duly organized, validly existing and in good standing as a corporation under the
laws of the Commonwealth of Virginia and is qualified to do business in each
jurisdiction where its ownership of property or conduct of business requires
such qualification and where failure to qualify could have a material adverse
effect on the Company or its property or business or on the ability of the
Company to pay or perform the Obligations, (2) has the corporate power and
authority and the legal right to own and operate its property and to conduct
business in the manner in which it does and proposes so to do, and (3) is in
compliance with all Requirements of Law and Contractual 

                                       14
<PAGE>
 
Obligations, the failure to comply with which could have a material adverse
effect on the business, operations, assets or financial or other condition of
the Company or on the Collateral or the Collateral Value of the Borrowing Base.

          5(d)  Corporate Power; Authorization; Enforceable Obligations.   The
                -------------------------------------------------------
Company has the corporate power and authority and the legal right to execute,
deliver and perform the Credit Documents and has taken all necessary corporate
action to authorize the execution, delivery and performance of the Credit
Documents. The Credit Documents have been duly executed and delivered on behalf
of the Company and constitute legal, valid and binding obligations of the
Company enforceable against the Company in accordance with their respective
terms, subject to the effect of applicable bankruptcy and other similar laws
affecting the rights of creditors generally and the effect of equitable
principles whether applied in an action at law or a suit in equity.

          5(e)  No Legal Bar.   The execution, delivery and performance of the
                ------------
Credit Documents, the borrowing hereunder and the use of the proceeds thereof,
will not violate any Requirement of Law or any Contractual Obligation of the
Company the violation of which could have a material adverse effect on the
business, operations, assets or financial or other condition of the Company or
on the Collateral or the Collateral Value of the Borrowing Base or create or
result in the creation of any Lien (except the Lien created by the Security
Agreement) on any assets of the Company.

          5(f)  No Material Litigation.   Except as disclosed on Exhibit E
                ----------------------                           ---------
hereto, no litigation, investigation or proceeding of or before any court,
arbitrator or Governmental Authority is pending or, to the knowledge of the
Company, threatened by or against the Company or against any of its properties
or revenues which is likely to be adversely determined and which, if adversely
determined, is likely to have a material adverse effect on the business,
operations, property or financial or other condition of the Company or on the
Collateral or the Collateral Value of the Borrowing Base.

          5(g)  Taxes.   To the best of the Company's knowledge, all tax returns
                -----
that are required to be filed by or on behalf of the Company have been filed and
all taxes shown to be due and payable on said returns or on any assessments made
against the Company or any of its property (other than taxes which are being
contested in good faith by appropriate proceedings and as to which the Company
has established adequate reserves in conformity with GAAP) have been paid and
taxes which unknown to the Company were not paid.

                                       15
<PAGE>
 
          5(h)  Investment Company Act.   The Company is not an "investment
                ----------------------  
company" or a company "controlled" by an "investment company" within the meaning
of the Investment Company Act of 1940, as amended.

          5(i)  Federal Reserve Board Regulations.   The Company is not engaged
                ---------------------------------
and will not engage, principally or as one of its important activities, in the
business of extending credit for the purpose of "purchasing" or "carrying" any
"margin stock" within the respective meanings of such terms under Regulation U.
No part of the proceeds of any Loan issued hereunder will be used, directly or
indirectly, for "purchasing" or "carrying" "margin stock" as so defined or for
any purpose which violates, or which would be inconsistent with, the provisions
of the Regulations of the Board of Governors of the Federal Reserve System.

          5(j)  ERISA.   The Company and each of its ERISA Affiliates are in
                -----
compliance in all respects with the requirements of ERISA and no Reportable
Event has occurred under any Plan maintained by the Company or any of its ERISA
Affiliates which is likely to result in the termination of such Plan for
purposes of Title IV of ERISA.

          5(k)  Assets.   The Company has good and marketable title to all
                ------
property and assets reflected in the financial statements referred to in
Paragraph 5(a) above, except property and assets sold or otherwise disposed of
in the ordinary course of business subsequent to the respective dates thereof.
The Company has no outstanding Liens on any of its properties or assets and
there are no security agreements to which the Company is a party, nor any title
retention agreements, whether in the form of leases or otherwise, of any
personal property except as permitted under Paragraph 7(a) below.

          5(l)  Securities Acts.   The Company has not issued any unregistered
                ---------------
securities in violation of the registration requirements of Paragraph 5 of the
Securities Act of 1933, as amended, or any other law, and is not violating any
rule, regulation or requirement under the Securities Act of 1933, as amended, or
the Securities and Exchange Act of 1934, as amended. The Company is not required
to qualify an indenture under the Trust Indenture Act of 1939, as amended, in
connection with its execution and delivery of the Note.

          5(m)  Consents, etc.   No consent, approval, authorization of, or
                -------------
registration, declaration or filing with, any Governmental Authority is required
on the part of the Company in connection with the execution and delivery of the
Credit Documents (other than filings to perfect the security interests granted
by it) or the performance of or compliance with the terms, provisions 

                                       16
<PAGE>
 
and conditions hereof or thereof.

          5(n)  Ownership and Subsidiaries.   As of the date hereof, ninety-nine
                --------------------------
percent (99%) of the economic interests in the Company are owned by NovaStar
Financial. The Company has no Subsidiaries.

     6.   Affirmative Covenants.   The Company hereby covenants and agrees with
          ---------------------
the Lender that, as long as any Obligations remain unpaid or the Lender has any
obligation to make Loans hereunder, the Company shall:

          6(a)  Financial Statements.   Furnish or cause to be furnished to the
                --------------------
Lender:

                (1)  Within ninety (90) days after the last day of each fiscal
     year of NovaStar Financial, statements of income and cash flows for such
     year, and balance sheets as of the end of such year, of each of NovaStar
     Financial, NFI Holding and the Company, presented fairly in accordance with
     GAAP (or with such non-GAAP principles as are disclosed to and approved by
     Lender from time to time) and accompanied by an unqualified report of a
     firm of independent certified public accountants acceptable to the Lender
     and including therewith a copy of any management letter from such certified
     public accountants, together with a consolidating schedule prepared by an
     officer of NovaStar Financial in form and substance acceptable to the
     Lender which reconciles and consolidates the above-referenced financial
     statements;

                (2)  Within forty-five (45) days after the last day of each
     calendar month, statements of income for such month, and balance sheets as
     of the end of such month, of each of NovaStar Financial, NFI Holding and
     the Company, accompanied in each case by a consolidating schedule prepared
     by an officer of NovaStar Financial in form and substance acceptable to the
     Lender which reconciles and consolidates the above-referenced financial
     statements and by a Covenant Compliance Certificate of the appropriate
     officer of NovaStar Financial, stating that all such financial statements
     are prepared fairly in accordance with GAAP (or with such non-GAAP
     principles as are disclosed to and approved by Lender from time to time)
     and demonstrating in detail satisfactory to the Lender compliance with the
     financial covenants set forth in Paragraphs 7(h) and 7(i) below as of and
     at the end of such month.

          6(b)  Certificates; Reports; Other Information.   Furnish or cause to
                ----------------------------------------
be furnished to the Lender:

                (1)  Within forty-five (45) days after the last day of each
     calendar month a collateral report, a commitment 

                                       17
<PAGE>
 
     report, a Hedging Report and a pipeline management report, all for said
     calendar month and each in a form approved by Lender and containing such
     other information as may be reasonably requested by Lender;

                (2)  Promptly, such additional financial and other information,
     including, without limitation, financial statements of any of NovaStar
     Financial, NFI Holding or the Company or any Approved Investor and
     information regarding the Collateral as the Lender may from time to time
     reasonably request;

                (3)  Promptly, and in any event within five (5) business days
     after received or sent by the Company, (i) true and complete copies of all
     audits, reports, studies and similar documentation prepared by, or on
     behalf of FHA, VA or the Department of Housing and Urban Development or
     similar agency relating to the Company's operations, servicing or lending
     practices or which have been done in connection with a review, extension or
     conditioning of any licenses and approvals issued to the Company by FHA or
     VA; and (ii) copies of all correspondence between any of the foregoing
     departments and agencies and the Company related to any such audits,
     reports, studies and similar documents; and

                (4)  Promptly, copies of any and all forms, reports, supplements
     or other documents of any kind filed by the Company with the Securities and
     Exchange Commission.

          6(c)  Payment of Indebtedness.   Pay or otherwise satisfy at or before
                -----------------------
maturity or before it becomes delinquent or accelerated, as the case may be, all
its Indebtedness (including taxes), except Indebtedness being contested in good
faith by appropriate proceedings and for which provision is made to the
satisfaction of the Lender for the payment thereof in the event the Company is
found to be obligated to pay such Indebtedness and which Indebtedness is
thereupon promptly paid by the Company.

          6(d)  Maintenance of Existence and Properties.   Maintain its
                ---------------------------------------
corporate existence and obtain and maintain all rights, privileges, licenses,
approvals, franchises, properties and assets necessary or desirable in the
normal conduct of its business, including but not limited to all approvals with
respect to FHA and VA, and comply with all Contractual Obligations and
Requirements of Law (including, without limitation, any Requirements of Law
under or in connection with ERISA), except where the failure to so comply is not
likely to have a material adverse effect on the business, operations, assets or
financial or other condition of the Company or on the Collateral or the
Collateral Value of the Borrowing Base.

                                       18
<PAGE>
 
          6(e)  Inspection of Property; Books and Records; Audits.
                -------------------------------------------------

                (1)  Keep proper books of record and account in which full, true
     and correct entries in conformity with GAAP (or with such non-GAAP
     principles as are disclosed to and approved by Lender from time to time)
     and all Requirements of Law shall be made of all dealings and transactions
     in relation to its business and activities; and

                (2)  Permit: (i) representatives of the Lender to (A) visit and
     inspect any of its properties and examine and make abstracts from any of
     its books and records at any reasonable time and as often as may reasonably
     be desired by the Lender (but, prior to the occurrence of an Event of
     Default, only upon not less than two Business Days' prior notice), and (B)
     discuss the business, operations, properties and financial and other
     condition of the Company with officers and employees of the Company, and
     with its independent certified public accountants, and (ii) representatives
     of the Lender to conduct periodic operational audits of the Company's
     business and operations.

          6(f)  Notices.   Promptly give written notice to the Lender of:
                -------

                (1)  The occurrence of any Potential Default or Event of Default
     known to responsible management personnel of the Company and the proposed
     method of cure thereof;

                (2)  Any litigation or proceeding affecting the Company or the
     Collateral which could have a material adverse effect on the Collateral,
     the Collateral Value of the Borrowing Base or the business, operations,
     property, or financial or other condition of the Company;

                (3)  A material adverse change known to responsible management
     personnel of the Company in the business, operations, property or financial
     or other condition of the Company; and

                (4)  Any changes in the following senior management positions of
     the Company: President, Chief Financial Officer or any Vice President.

          6(g)  Expenses.   Pay all reasonable out-of-pocket costs and expenses
                --------
(including fees and disbursements of legal counsel) of the Lender: (1) incident
to the preparation, negotiation and administration of the Credit Documents,
including with respect to or in connection with any waiver or amendment thereof
or thereto, (2) associated with any periodic audits conducted pursuant to

                                       19
<PAGE>
 
Paragraph 6(e)(2)(ii) above, and (3) incident to the enforcement of payment of
the Obligations, whether by judicial proceedings or otherwise, including,
without limitation, in connection with bankruptcy, insolvency, liquidations
reorganization moratorium or other similar proceedings involving the Company or
a "workout" of the Obligations. The obligations of the Company under this
Paragraph 6(g) shall be effective and enforceable whether or not any Loan is
advanced by the Lender hereunder and shall survive payment of all other
Obligations.

          6(h)  Credit Documents.   Comply with and observe all terms and
                ----------------
conditions of the Credit Documents.

          6(i)  Insurance.   Obtain and maintain insurance with responsible
                ---------
companies in such amounts and against such risks as are usually carried by
corporations engaged in similar businesses similarly situated, including,
without limitation, errors and omissions coverage and fidelity coverage in form
and substance acceptable under FNMA, FHLMC or GNMA guidelines, and furnish the
Lender on request full information as to all such insurance, and to provide
within five (5) days after receipt, certificates or other documents evidencing
the renewal of each such policy.

          6(j)  Wet Funding Mortgage Loan Transmittal Form.   Furnish or cause
                ------------------------------------------
to be furnished to the Lender, with each Eligible Mortgage Loan shipped or
delivered which is of the type described in the proviso contained in subsection
(o) of the definition of Eligible Mortgage Loan, a Wet Funding Mortgage Loan
Transmittal Form substantially in the form attached as Exhibit K hereto.
                                                       --------- 
     7.   Negative Covenants.  The Company hereby agrees that, as long as any
          ------------------
Obligations remain unpaid or the Lender has any obligation to make Loans
hereunder, the Company shall not at any time, directly or indirectly:

          7(a)  Liens.   Create, incur, assume or suffer to exist, any Lien upon
                -----
the Collateral except as contemplated by the Security Agreement, or create,
incur, assume or suffer to exist any Lien upon any of its other property and
assets (including servicing rights) except:

                (1)  Liens for current taxes, assessments or other governmental
     charges which are not delinquent or which remain payable without penalty,
     or the validity of which are contested in good faith by appropriate
     proceedings upon stay of execution of the enforcement thereof, provided the
     Company shall have set aside on its books and shall maintain adequate
     reserves for the payment of same in conformity with GAAP;

                (2)  Liens, deposits or pledges made to secure 

                                       20
<PAGE>
 
     statutory obligations, surety or appeal bonds, or bonds for the release of
     attachments or for stay of execution, or to secure the performance of bids,
     tenders, contracts (other than for the payment of borrowed money), leases
     or for purposes of like general nature in the ordinary course of the
     Company's business;

                (3)  Purchase money security interests for property (except
     Mortgage Loans) hereafter acquired, conditional sale agreements, or other
     title retention agreements, with respect to property hereafter acquired;
     provided, however, that no such security interest or agreement shall affect
     any servicing rights or extend to any property other than the property
     acquired; and

                (4)  Liens securing Permitted Secured Debt.

          7(b)  Indebtedness.   Create, incur, assume or suffer to exist, or
                ------------
otherwise become or be liable in respect of any Indebtedness except:

                (1)  The Obligations;

                (2)  Indebtedness reflected in the financial statements referred
     to in Paragraph 5(a) above;

                (3)  Trade debt incurred in the ordinary course of business,
     paid within thirty (30) days after the same has become due and payable or
     which is being contested in good faith, provided provision is made to the
     satisfaction of the Lender for the eventual payment thereof in the event it
     is found that such contested trade debt is payable by the Company;

                (4)  Indebtedness secured by Liens permitted under Paragraph
     7(a) above;

                (5)  Liabilities incurred as "seller/repurchaser" under
     repurchase agreements covering Mortgage-Backed Securities or Mortgage Loans
     in customary form;

                (6)  Capitalized Lease Obligations in an aggregate amount not to
     exceed at any one time outstanding $250,000.00;

                (7)  Liabilities arising out of collateralized mortgage
     obligations created by the Company or entities created by the Company; and

                (8)  Permitted Other Debt.

                                       21
<PAGE>
 
          7(c)  Consolidation and Merger; Change of Business.   Liquidate or
                --------------------------------------------
dissolve or enter into any consolidation, merger, partnership, joint venture,
syndicate or other combination or make any change in the nature of its business
as a mortgage banker as presently conducted.

          7(d)  Acquisitions.   Purchase or acquire or incur liability for the
                ------------
purchase or acquisition of any or all of the assets or business of any Person,
other than in the normal course of business as currently conducted (it being
expressly agreed and understood that the acquisition of non-recourse servicing
is a normal course of business activity and that the acquisition of recourse
servicing is not a normal course of business activity).

          7(e)  Transfer of Stock.   Permit the acquisition, purchase,
                -----------------
redemption, retirement, transfer or issuance of any shares of its capital stock
now or hereafter outstanding which would result in (i) prior to the NFI Holding
Delivery Date, NovaStar Financial owning less than ninety-nine percent (99%) of
the economic interest in the Company, and (ii) on and after the NFI Holding
Delivery Date, NFI Holding owning less than one hundred percent (100%) of its
outstanding capital stock.

          7(f)  Investments; Advances; Guaranties.   Make or commit to make any
                ---------------------------------
advance, loan or extension of credit (other than Mortgage Loans made in the
ordinary course of the Company's business) or capital contribution to, or
purchase any stocks, bonds, notes, debentures or other securities of, or make
any other investment in, or guaranty the indebtedness or other obligations of,
any Person.

          7(g)  Sale of Assets.   Sell, lease, assign, transfer or otherwise
                --------------
dispose of any of its assets (other than obsolete or worn out property), whether
now owned or hereafter acquired, other than in the ordinary course of business
as currently conducted and at fair market value (it being expressly agreed and
understood that the sale or other disposition of Mortgage-Backed Securities and
Mortgage Loans with or without servicing released and of mortgage servicing
rights is in the ordinary course of business).

          7(h)  Required Equity Ratio.   Permit the ratio at any date of
                ---------------------
Required Equity to Shareholder Equity to be more than 1.0:1.0.

          7(i)  Minimum Adjusted Tangible Net Worth.  Permit Adjusted Tangible
                -----------------------------------
Net Worth as of the last day of any fiscal quarter to be less than the greater
of (i) eighty percent (80%) of the net proceeds from the Equity Issuance, and
(ii) $30,000,000.

     8.   Events of Default. Upon the occurrence of any of the 
          -----------------

                                       22
<PAGE>
 
following events (an "Event of Default"):

          8(a)  The Company shall fail to pay principal or interest on any Loan
or any fee payable pursuant to Paragraph 2(l) above or any amount payable
pursuant to Paragraph 2(f)(2) above when due; or

          8(b)  Any representation or warranty made or deemed made by the
Company or either Guarantor in any Credit Document or in connection with any
Credit Document shall be inaccurate or incomplete in any respect on or as of the
date made or deemed made; or

          8(c)  The Company shall fail to maintain its corporate existence or
shall default in the observance or performance of any covenant or agreement
contained in Paragraph 7 above or in the Security Agreement; or

          8(d)  The Company shall fail to observe or perform any other term or
provision contained in the Credit Documents and such failure shall continue for
thirty (30) days; or

          8(e)  The Company shall default in any payment of principal of or
interest on any Indebtedness in the aggregate principal amount of $100,000.00 or
more (and without regard for the dollar amount of the defaulted payment), or any
other event shall occur, the effect of which is to permit such Indebtedness to
be declared or otherwise to become due prior to its stated maturity; or

          8(f)  (1)  The Company or either Guarantor shall commence any case,
proceeding or other action (i) relating to bankruptcy, insolvency,
reorganization or relief of debtors, seeking to have an order for relief entered
with respect to the Company or either Guarantor, or seeking to adjudicate the
Company or either Guarantor a bankrupt or insolvent, or seeking reorganization,
arrangement, adjustment, winding-up, liquidation, dissolution, composition or
other relief with respect to the Company or either Guarantor or the debts of any
of them, or (ii) seeking appointment of a receiver, trustee, custodian or other
similar official for the Company or for all or any substantial part of the
Company's assets, or the Company or either Guarantor shall make a general
assignment for the benefit of its, his or their creditors; or (2) there shall be
commenced against the Company or either Guarantor any case, proceeding or other
action of a nature referred to in clause (1) above which (i) results in the
entry of an order for relief or any such adjudication or appointment, or (ii)
remains undismissed, undischarged or unbonded for a period of sixty (60) days;
or (3) there shall be commenced against the Company or either Guarantor any
case, proceeding or other action seeking 

                                       23
<PAGE>
 
issuance of a warrant of attachment, execution, distraint or similar process
against all or substantially all of the assets of any of them which results in
the entry of an order for any such relief which shall not have been vacated,
discharged, stayed, satisfied or bonded pending appeal within sixty (60) days
from the entry thereof; or (4) the Company or either Guarantor shall take any
action in furtherance of, or indicating its, his or their consent to, approval
of, or acquiescence in (other than in connection with a final settlement), any
of the acts set forth in clauses (1), (2) or (3) above; or (5) the Company or
either Guarantor shall generally not, or shall be unable to, or shall admit in
writing its, his or their inability to pay its, his or their debts as they
become due; or

          8(g)  (1)  The Company or any of its ERISA Affiliates shall engage in
any "prohibited transaction" (as defined in Section 406 of ERISA or Section 4975
of the Code) involving any Plan, (2) any "accumulated funding deficiency" (as
defined in Section 302 of ERISA), whether or not waived, shall exist with
respect to any Plan, (3) a Reportable Event shall occur with respect to, or
proceedings shall commence to have a trustee appointed, or a trustee shall be
appointed, to administer or to terminate, any Single Employer Plan, which
Reportable Event or institution of proceedings is, in the reasonable opinion of
the Lender, likely to result in the termination of such Plan for purposes of
Title IV of ERISA, and, in the case of a Reportable Event, the continuance of
such Reportable Event unremedied for ten days after notice of such Reportable
Event pursuant to Section 4043(a), (c) or (d) of ERISA is given or the
continuance of such proceedings for ten days after commencement thereof, as the
case may be, (4) any Single Employer Plan shall terminate for purposes of Title
IV of ERISA, (5) any withdrawal liability to a Multi-Employer Plan shall be
incurred by the Company or any of its ERISA Affiliates or (6) any other event or
condition shall occur or exist; and in each case in clauses (1) through (6)
above, such event or condition, together with all other such events or
conditions, if any, is likely to subject the Company or any of its respective
ERISA Affiliates to any tax, penalty or other liabilities in the aggregate
material in relation to the business, operations, property or financial or other
condition of the Company or any of its ERISA Affiliates; or

          8(h)  One or more judgments or decrees in an aggregate amount in
excess of $500,000.00 shall be entered against the Company and all such
judgments or decrees shall not have been vacated, discharged, stayed, satisfied
or bonded pending appeal within sixty (60) days from the entry thereof; or

          8(i)  Either Guarantor shall fail to observe or perform any term or
provision of the Guaranty to which such Guarantor is a

                                       24
<PAGE>
 
party or shall attempt to rescind or revoke such Guaranty, with respect to
future transactions or otherwise; or

                  8(j) Any acquisition, purchase, redemption, retirement,
transfer or issuance of the company's capital stock shall occur in violation of
Paragraph 7(e) above; or

                  8(k) Either W. Lance Anderson or Scott F. Hartman is removed
from his current position with the Company or his duties in such position are
diminished in any material respect; or

                  8(l) The NFI Holding Delivery Date shall not occur within
thirty (30) days of the date of this Agreement; or

                  8(m) The Company shall not have delivered to the Lender
satisfactory evidence from the Secretary of State of California that the Company
is qualified as a foreign corporation in such state within ninety (90) days of
the date of this Agreement.

                                     THEN:

                       (1) Automatically upon the occurrence of an Event of
Default under Paragraph 8(f) above; and

                       (2) In all other cases, at the option of the Lender,

the Lender's obligation to make Loans hereunder shall terminate and the
principal balance of outstanding Loans and interest accrued but unpaid thereon
shall become immediately due and payable, without demand upon or presentment to
the Company, which are expressly waived by the Company.

         9.       Miscellaneous Provisions.
                  ------------------------

                  9(a) Assignment. The Company may not assign its rights or
                       ----------
obligations under this Agreement without the prior written consent of the
Lender. The Lender shall not assign its rights and obligations under this
Agreement to any other party not a party to this Agreement as of the date
hereof; provided, however, that the Lender may at any time pledge or assign all
        --------  -------
or any portion of the Lender's rights under this Agreement and the other Credit
Documents to a Federal Reserve Bank. Subject to the foregoing, all provisions
contained in this Agreement or any document or agreement referred to herein or
relating hereto shall inure to the benefit of the Lender, its successors and
assigns, and shall be binding upon the Company, its successors and assigns.

                  9(b) Amendment.  Neither this Agreement nor any of the other
                       ---------
Credit Documents may be amended or terms or provisions 

                                       25
<PAGE>
 
hereof or thereof waived unless such amendment or waiver is in writing and
signed by the Lender and the Company. It is expressly agreed and understood that
the failure by the Lender to elect to accelerate amounts outstanding hereunder
or to terminate the obligation of the Lender to make Loans hereunder shall not
constitute an amendment or waiver of any term or provision of this Agreement.

                  9(c)  Cumulative Rights; No Waiver.  The rights, powers and 
                        ----------------------------
remedies of the Lender under the Credit Documents are cumulative and in addition
to all rights, powers and remedies provided under any and all agreements among
the Company and the Lender relating hereto, at law, in equity or otherwise. Any
delay or failure by the Lender to exercise any right, power or remedy shall not
constitute a waiver thereof by the Lender, and no single or partial exercise by
the Lender of any right, power or remedy shall preclude other or further
exercise thereof or any exercise of any other rights, powers or remedies.

                  9(d)  Entire Agreement.  This Agreement and the documents 
                        ----------------
and agreements referred to herein embody the entire agreement and understanding
between the parties hereto and supersede all prior agreements and understandings
relating to the subject matter hereof and thereof.


                  9(e)  Survival.  All representations, warranties, covenants 
                        --------
and agreements on the part of the Company and the Guarantors contained in the
Credit Documents shall survive the termination of this Agreement and shall be
effective until the Obligations are paid and performed in full or longer as
expressly provided herein.


                  9(f)  Notices. All notices given by any party to the others
                        -------
under the Credit Documents shall be in writing unless otherwise provided for
herein, delivered personally or by depositing the same in the United States
mail, registered, with postage prepaid, addressed to the party at the address
set forth on Schedule I attached hereto. Any party may change the address to
             ----------
which notices are to be sent by notice of such change to each other party given
as provided herein. Such notices shall be effective on the date received or, if
mailed, on the third Business Day following the date mailed.

                  9(g)  Governing Law.  This Agreement shall be governed by and
                        -------------
construed in accordance with the laws of the State of North Carolina.

                  9(h)  Sub-Participation by Lender.  The Lender may at any 
                        --------------------------- 
time sell to one or more financial institutions (each of such financial
institutions being herein called a "Participant") participating interests in any
of the Obligations held by the Lender and its commitments hereunder; provided,
however, that: (1) no participation contemplated by this Paragraph 9(h) shall
relieve the Lender from its obligations hereunder or under any other Credit
Document; (2) the Lender shall remain solely respon-

                                       26
<PAGE>
 
sible for the performance of such obligations; and (3) the Company shall
continue to deal solely and directly with the Lender in connection with the
Lender's rights and obligations under the Credit Documents.

                  9(i)  Counterparts. This Agreement and the other Credit
                        ------------
Documents may be executed in any number of counterparts, all of which together
shall constitute one agreement.

                  9(j)  Exculpatory Provisions.  Neither the Lender nor any of
                        ---------------------- 
its officers, directors, employees, agents, counsel, attorneys-in-fact or
Affiliates shall be liable to the Company for any action taken or omitted to be
taken by it or such Person under or in connection with the Credit Documents or
with respect to the Collateral (except for its or such Person's own gross
negligence or willful misconduct).


                  9(k)  Indemnification. The Company agrees to indemnify, defend
                        ---------------                     
and hold harmless the Lender from and against any and all claims, obligations,
penalties, actions, suits, judgments, costs, disbursements, losses, liabilities
and damages (including, without limitation, reasonable attorneys' fees) of any
kind whatsoever which may at any time be imposed on, assessed against or
incurred by the Lender in any way relating to or arising out of the Credit
Documents or any documents contemplated by or referred to therein or the
transactions contemplated thereby or any action taken or omitted to be taken by
the Lender in connection with the foregoing; provided, the Company shall not be
liable for any portion of any such claims, obligations, etc., arising out of or
resulting from the gross negligence or willful misconduct of the Lender. The
indemnification obligations of the Company under this Paragraph 9(k) shall
survive termination of this Agreement and payment in full of the Obligations.

         10.  Definitions.  For purposes of this Agreement, the terms set 
              -----------
forth below shall have the following meanings:

         "A Paper" shall have the meaning set forth on Exhibit L attached
          -------                                      ---------
hereto.

         "Additional Required Documents" shall mean for any Mortgage Loan those
          -----------------------------
items described on Exhibit F attached hereto.
                   ---------

         "Adjusted Tangible Net Worth" shall mean at any date:
          --------------------------- 

                  (a)  Book Net Worth, minus
                                       -----

                  (b)  The sum of (1) all assets which would be classified as
intangible assets under GAAP, including, without limitation, purchased and
capitalized value of servicing rights, 

                                       27
<PAGE>
 
goodwill (whether representing the excess cost over book value of assets
acquired or otherwise), patents, trademarks, trade names, copyrights, franchises
and deferred charges (including, without limitation, unamortized debt discount
and expense, organization costs and research and product development costs) plus
(2) all receivables from directors, officers and shareholders of NovaStar
Financial and its consolidated Subsidiaries, plus
                                             ----

                  (c)  The amount of reserves of NovaStar and its consolidated 
Subsidiaries for credit losses (as referenced on the financial statements
referred to in Paragraph 6(a) above), minus
                                      -----

                  (d)  The amount of unrealized gains on debt securities 
(as defined in FASB 115) of NovaStar Financial and its consolidated
Subsidiaries, plus 
              ----

                  (e)  The amount of unrealized losses on debt securities (as
defined in FASB 115) of NovaStar Financial and its consolidated Subsidiaries.

         "Affiliate" shall mean, as to any Person, any other Person directly 
          ---------
or indirectly controlling, controlled by or under direct or indirect common
control with, such Person. "Control" as used herein means the power to direct
the management and policies of such Person.


         "Agreement" shall mean this Agreement, as the same may be amended,
          ---------
extended or replaced from time to time.

         "Applicable Fed Funds-Based Rate" shall mean a rate of interest equal
          -------------------------------
to the Fed Funds Rate plus one and one-quarter percent (1.25%) per annum.

         "Applicable LIBOR-Based Rate" shall mean, with respect to any
          ---------------------------
Eurodollar Loan for the Interest Period applicable to such Eurodollar Loan, the
rate per annum (rounded upward, if necessary, to the next higher 1/32 of one
percent (.03125%)) calculated in accordance with the following formula:

                                           
                                           LR    + 1.125
                                        ------- 
         Applicable LIBOR-Based Rate  =  1-LRP

where

         LR       =        LIBOR Rate
         LRP      =        LIBOR Reserve Percentage

         "Approved Investor" shall mean FNMA, FHLMC or any other Person
          ----------------- 
pre-approved in writing (which pre-approval may be limited in dollar amounts by
type and otherwise) by the Lender (including 

                                       28
<PAGE>
 
those shown on Schedule II) and which approval has not been revoked by the
               -----------
Lender in its sole discretion (such revocation to be effective on the tenth
Business Day following notice thereof given to the Company in writing).

         "Book Net Worth" shall mean the excess of total assets of NovaStar
          --------------
Financial and its consolidated Subsidiaries over Total Liabilities of NovaStar
Financial and its consolidated Subsidiaries determined in accordance with GAAP
(or such non-GAAP principles as may be disclosed to and approved by Lender from
time to time).

         "Borrowing Base" shall mean at any date all Eligible Mortgage Loans
          --------------
delivered to and held by the Lender or otherwise identified as Collateral under
the Security Agreement as collateral security for the Obligations.

         "Borrowing Base Schedule" shall mean a schedule prepared by the Lender
          -----------------------
and certified to by the Company in the form of that attached hereto as Exhibit
                                                                       ------- 
G.

         "Bulk Acquisition" shall mean the acquisition by the Company of a
          ----------------
seasoned loan pool consisting of Mortgage Loans with an aggregate outstanding
principal balance equal to or greater than $2,000,000.

         "Business Day" shall mean any day other than a Saturday, a Sunday or a
          ------------
day on which banks in Charlotte, North Carolina are authorized or obligated to
close their regular banking business.

         "Capitalized Lease Obligations" of any Person shall mean the
          ----------------------------- 
obligations of such Person to pay rent or other amounts under any lease of (or
other arrangement conveying the right to use) real or personal property, or a
combination thereof, which obligations are required to be classified and
accounted for as capital leases on a balance sheet of such Person under GAAP
and, for the purposes of this Agreement, the amount of such obligations at any
time shall be the capitalized amount thereof at such time determined in
accordance with GAAP.

         "Code" shall mean the Internal Revenue Code of 1986, as amended.
          ----

         "Collateral" shall have the meaning given such term in the Security
          ----------  
Agreement.

         "Collateral Value of the Borrowing Base" shall mean at any date the sum
          --------------------------------------
of the Unit Collateral Values of all Eligible Mortgage Loans included in the
Borrowing Base at such date (including Eligible Mortgage Loans shipped into
pools supporting 

                                       29
<PAGE>
 
Warehouse Related MBSs pending sale of such Warehouse Related MBSs and delivery
of the sale proceeds thereof to the Settlement Account).

         "Commonly Controlled Entity" of a Person shall mean a Person, whether
          -------------------------- 
or not incorporated, which is under common control with such Person within the
meaning of Section 414(c) of the Internal Revenue Code.

         "Company" shall have the meaning given such term in the introductory
          -------
paragraph hereof.

         "consolidated Subsidiary" shall mean, for the purpose of this
          ----------------------- 
Agreement, either (i) a Subsidiary which is required by GAAP to be consolidated
           ------
for the purposes of financial statement preparation and reporting, or (ii) any
                                                                   --  
corporation, partnership, or joint venture more than fifty percent (50%) of the
economic interest in which shall, at the time as of which any determination is
made, be owned, either directly or through Subsidiaries.

         "Contact Office" shall mean the office of the Lender at One First Union
          --------------
Center, 301 South College Street, Charlotte, North Carolina 28288.

         "Contractual Obligation" as to any Person shall mean any provision of
          ----------------------
any security issued by such Person or of any agreement, instrument or
undertaking to which such Person is a party or by which it or any of its
property is bound.

         "Corporate Base Rate" shall mean a fluctuating rate per annum announced
          -------------------
from time to time by the Lender to be its "Prime Rate" as such "Prime Rate" may
change from time to time, said changes to occur on the first date the "Prime
Rate" changes; it being understood that the "Prime Rate" is the rate announced
by the Lender from time to time as its "Prime Rate" and is not necessarily the
lowest interest rate charged by the Lender to its customers.

         "Covenant Compliance Certificate" shall mean a certificate in the form
          -------------------------------
of Exhibit H attached hereto.
   ---------
         "Credit Documents" shall mean this Agreement, the Security Agreement,
          ---------------- 
the Guaranties, the Note and each other document, instrument and agreement
executed by the Company or either Guarantor in connection herewith, as any of
the same may be amended, extended or replaced from time to time.

         "Credit Limit" shall mean $30,000,000.00.
          ------------

         "Eligible Mortgage Loan" shall mean a Mortgage Loan with 
          ----------------------

                                       30
<PAGE>
 
respect to which each of the following statements shall be accurate and complete
(and the Company by confirming the inclusion of such Mortgage Loan in any
computation of the Collateral Value of the Borrowing Base shall be deemed to so
represent and warrant to the Lender at and as of the date of such computation):

                  (a)      Said Mortgage Loan is a binding and valid obligation
of the Obligor thereon, in full force and effect and enforceable in accordance
with its terms.

                  (b)      Said Mortgage Loan is genuine in all respects as 
appearing on its face and as represented in the books and records of the Company
and all information set forth therein is true and correct.

                  (c)      Said Mortgage Loan is free of any default of any 
party thereto (including the Company), other than as expressly permitted
pursuant to subparagraph (d) below, counterclaims, offsets and defenses and from
any rescission, cancellation or avoidance, whether by operation of law or
otherwise.

                  (d) No payment under said Mortgage Loan is more than sixty
(60) days past due the payment due date set forth in the underlying promissory
note and deed of trust (or mortgage); provided, however, that a Mortgage Loan
                                      --------  -------
which is more than sixty (60) days delinquent may be an Eligible Mortgage Loan
so long as (i) said Mortgage Loan is not more than ninety (90) days delinquent,
and (ii) said Mortgage Loan, when added to the Unit Collateral Values of all
other Mortgage Loans which are more than sixty (60) days delinquent, does not
exceed five percent (5%) of the Credit Limit.

                  (e)      Said Mortgage Loan contains the entire agreement of 
the parties thereto with respect to the subject matter thereof, has not been
modified or amended in any respect and is free of concessions or understandings
with the Obligor thereon of any kind not expressed in writing therein.

                  (f)      Said Mortgage Loan is in all respects as required by
and in accordance with all applicable laws and regulations governing the same,
including, without limitation, the federal Consumer Credit Protection Act and
the regulations promulgated thereunder and all applicable usury laws and
restrictions, and all notices, disclosures and other statements or information
required by law or regulation to be given, and any other act required by law or
regulation to be performed, in connection with said Mortgage Loan have been
given and performed as required.

                  (g)      All advance payments and other deposits on said 
Mortgage Loan have been paid in cash, and no part of said sums has 

                                       31
<PAGE>
 
been loaned, directly or indirectly, by the Company to the Obligor and there
have been no prepayments on account of said Mortgage Loan.

                  (h)      At all times said Mortgage Loan will be free and 
clear of all Liens, except in favor of the Lender.

                  (i)      The Property covered by said Mortgage Loan is insured
against loss or damage by fire and all other hazards normally included within
standard extended coverage in accordance with the provisions of said Mortgage
Loan with the Company named as a loss payee thereon.

                  (j)      The Property covered by said Mortgage Loan is free
and clear of all Liens except the Lien securing the Mortgage Loan subject only
to (1) the Lien of current real property taxes and assessments not yet due and
payable; (2) covenants, conditions and restrictions, rights of way, easements
and other matters of the public record, as of the date of recording, as are
acceptable to mortgage lending institutions generally and specifically referred
to in a lender's title insurance policy delivered to the originator of the
Mortgage Loan and (i) referred to or otherwise considered in the appraisal made
for the originator of the Mortgage Loan or (ii) which do not materially
adversely affect the appraised value of the Property as set forth in such
appraisal; (3) other matters to which like properties are commonly subject which
do not materially interfere with the benefits of the security intended to be
provided by the Mortgage Loan or the use, enjoyment, value or marketability of
the related Property; (4) Liens subordinate in priority to the Lien securing the
Mortgage Loan, and (5) if the Lien securing such Mortgage Loan is a second
priority Lien, one Lien securing indebtedness which is prior to the Lien
securing the Mortgage Lien.

                  (k)      If said Mortgage Loan has been withdrawn from the 
possession of the Lender and:

                           (1) If said Mortgage Loan was withdrawn by the
         Company for purposes of correcting clerical or other non-substantive
         documentation problems pursuant to a trust receipt, as permitted under
         Paragraph 6 of the Security Agreement, the Unit Collateral Value of
         said Mortgage Loan when added to the Unit Collateral Value of other
         Mortgage Loans included in the calculation of the Collateral Value of
         the Borrowing Base the promissory notes for which have been similarly
         withdrawn by the Company does not exceed one percent (1%) of the Credit
         Limit, and the promissory note and other documents relating to said
         Mortgage Loan are returned to the Lender within fifteen (15) Business
         Days from the date of withdrawal;

                                       32
<PAGE>
 
                           (2) If said Mortgage Loan was shipped by the 
         Lender directly to a permanent investor for purchase, the full
         purchase price therefor has been received by the Lender (or said
         Mortgage Loan has been returned to the Lender) within forty-five (45)
         days from the date of shipment by the Lender; and

                           (3) If said Mortgage Loan was shipped by the 
         Lender directly to a custodian for purposes of formation of a pool
         supporting a Mortgage-Backed Security, the Mortgage-Backed Security is
         issued, sold and the purchase price therefor has been received by the
         Lender (or said Mortgage Loan has been returned to the Lender) within
         forty-five (45) days from the date of shipment by the Lender.

                  (l) (i) In the case of a Mortgage Loan which is considered to
be A Paper and which was not acquired as part of a Bulk Acquisition, the date of
the underlying promissory note is no earlier than three hundred and sixty-five
(365) days prior to the date said Mortgage Loan is first included in the
Borrowing Base; and (ii) in the case of a Mortgage Loan which is considered to
be Non-A Paper and which was not acquired as part of a Bulk Acquisition, the
date of the underlying promissory note is no earlier than one hundred and eighty
(180) days prior to the date said Mortgage Loan is first included in the
Borrowing Base (provided, that a Mortgage Loan acquired as part of a Bulk
                --------  
Acquisition may have an underlying promissory note of any date).

                  (m)      If said Mortgage Loan is FHA insured or VA 
guaranteed, such insurance or guaranty (or a binding commitment to issue such
insurance or guaranty) is in full force and effect.

                  (n)      The improvements on the Property consist of a 
completed one-to-four unit single family residence, including but not limited to
a condominium, planned unit development or townhouse but excluding in any event
a co-op.

                  (o)      There has been delivered to the Lender the Required
Documents for said Mortgage Loan; provided, however, that the Required Documents
for said Mortgage Loan may be delivered to the Lender within five (5) Business
Days of the inclusion of said Mortgage Loan in the Borrowing Base so long as the
Unit Collateral Value of said Mortgage Loan for which the Required Documents are
delivered within five (5) Business Days after its inclusion in the Borrowing
Base, when added to the Unit Collateral Value of all other such Mortgage Loans
for which the Required Documents are delivered within five (5) Business Days
after its inclusion in the Borrowing Base, does not exceed thirty percent (30%)
of the Credit Limit during the first five (5) Business Days and the last five

                                       33
<PAGE>
 
(5) Business Days of each month, and (ii) twenty percent (20%) of the Credit
Limit at all other times.

                  (p) Said Mortgage Loan has not been included in the Borrowing
Base for more than one hundred and eighty (180) days; provided, however that a
                                                      --------  ------- 
Mortgage Loan which is included in the Borrowing Base for more than one hundred
and eighty (180) days may be an Eligible Mortgage Loan so long as (i)(A) said
Mortgage Loan is of a type described in the proviso to subsection (d) of this
definition of "Eligible Mortgage Loan", and (B) said Mortgage Loan is not
included in the Borrowing Base for more than three hundred and sixty (360) days,
or (ii) (A) said Mortgage Loan is not included in the Borrowing Base for more
than three hundred and sixty (360) days, and (B) said Mortgage Loan, when added
to the Unit Collateral Values of all other Mortgage Loans which are included in
the Borrowing Base for more than one hundred and eighty (180) days subject to
this section (B) of this proviso of this subsection (p), does not exceed twenty
percent (20%) of the Credit Limit.

                  (q) Said Mortgage Loan has not previously been included
in the Borrowing Base, then shipped to an investor or certifying custodian and
returned, for whatever reason, to the Lender.

                  (r) The Company obtained such appraisal in connection 
with the origination of said Mortgage Loan as would satisfy all appraisal
requirements for said Mortgage Loan if such had been originated by a federally
insured depositary institution.

         "Equity Issuance" shall mean that certain initial issuance by NovaStar
          ---------------
Financial of convertible preferred stock which occurred on December 9, 1996.

         "ERISA" shall mean the Employee Retirement Income Security Act of 1974,
          ----- 
as the same may from time to time be supplemented or amended.

         "ERISA Affiliate" shall mean, with respect to any Person, any trade or
          --------------- 
business (whether or not incorporated) that is a member of the group of which
such Person is a member and which is treated as a single employer under Section
414 of the Internal Revenue Code of 1986, as amended, and the rules and
regulations thereunder in effect from time to time.

         "Eurodollar Business Day" shall mean a Business Day upon which
          ----------------------- 
commercial banks in London, England are open for domestic and international
business.

         "Eurodollar Loans" shall mean Loans hereunder at such time as they are
          ----------------
bearing interest at the Applicable LIBOR-Based Rate.

                                       34
<PAGE>
 
         "Event of Default" shall have the meaning set forth in Paragraph 8
          ----------------
above.

         "FHA" shall mean the Federal Housing Administration and any successor
          ---
agency.

         "Fair Market Value" shall mean, with respect to any Mortgage Loan, the
          ----------------- 
market value of such Mortgage Loan as determined by Lender in its sole
discretion from time to time but no less frequently than monthly.

         "Fed Funds Loans" shall mean Loans hereunder at such time as they are
          ---------------
bearing interest at the Applicable Fed Funds-Based Rate.

         "Fed Funds Rate" shall mean, for any day, a fluctuating interest rate
          --------------
per annum equal to the weekly weighted average of the rates on overnight Federal
funds transactions with members of the Federal Reserve System arranged by
Federal funds brokers for each seven-day period ending on Wednesday of each week
which includes such day, as published in Statistical Release H.15 by the Federal
Reserve System, or, if such rate is not so published for any week, the average
of the quotations for such day on such transactions received by Lender from
three Federal funds brokers of recognized standing selected by Lender.

         "Funding Account" shall mean, collectively, Accounts No. 
          ---------------                                         --------------
and No.                    maintained in Lender's name alone with the Lender at
       ------------------- 
the Contact Office.

         "GAAP" shall mean generally accepted accounting principles in the
          ----
United States of America in effect from time to time.

         "Governmental Authority" shall mean any nation or governments any state
          ----------------------
or other political subdivision thereof, or any entity exercising executive,
legislative, judicial, regulatory or administrative functions of or pertaining
to government.

         "Guaranties" shall mean, collectively, the NovaStar Financial Guaranty
          ----------
and the NFI Holding Guaranty.

         "Guarantors" shall mean, collectively, Novastar Financial and NFI
          ----------
Holding.

         "Hedging Report" shall mean a report prepared by the Company in the
          --------------
form of that attached hereto as Exhibit M.
                                ---------

         "Indebtedness" of any Person shall mean all items of indebtedness
          ------------
which, in accordance with GAAP and practices thereof, would be included in
determining liabilities as shown on the liability 

                                       35
<PAGE>
 
side of a statement of condition of such Person as of the date as of which
indebtedness is to be determined, including: without limitation, all obligations
for money borrowed and Capitalized Lease Obligations, all amounts for which such
Person may be obligated under gestation or other repurchase facilities, and
shall also include all indebtedness and liabilities of others assumed or
guaranteed by such Person or in respect of which such Person is secondarily or
contingently liable (other than by endorsement of instruments in the course of
collection) whether by reason of any agreement to acquire such indebtedness or
to supply or advance sums or otherwise.


         "Interim Date" shall mean December 31, 1996.
          ------------

         "Interest Period" shall mean with respect to any Loan which is a
          ---------------
Eurodollar Loan, the period commencing on the date advanced and ending one
month, two months or three months thereafter, as designated in the related Loan
Request; provided, however, that (a) any Interest Period which would otherwise
end on a day which is not a Eurodollar Business Day shall be extended to the
next succeeding Eurodollar Business Day unless by such extension it would fall
in another calendar month, in which case such Interest Period shall end on the
immediately preceding Eurodollar Business Day; (b) any Interest Period
applicable to a Eurodollar Loan which begins on a day for which there is no
numerically corresponding day in the calendar month during which such Interest
Period is to end shall, subject to the provisions of clause (a) hereof, end on
the last day of such calendar month; and (c) no such Interest Period shall
extend beyond the Maturity Date.

         "Lender" shall have the meaning given such term in the introductory
          ------
paragraph hereof.

         "LIBOR Rate" shall mean, with respect to any Eurodollar Loan for the
          ----------
Interest Period applicable to such Eurodollar Loan, the arithmetic average of
the rates at which deposits in immediately available U.S. dollars in an amount
equal to the aggregate amount of Eurodollar Loans proposed to be subject to such
rates having a maturity approximately equal to such Interest Period are offered
to or by reference banks in the London interbank market, as determined by the
Lender in accordance with its standard practices at approximately 11:00 a.m.
(London time) two Eurodollar Business Days prior to the first day of such
Interest Period.

         "LIBOR Reserve Percentage" shall mean for any day, that percentage
          ------------------------
expressed as a decimal, which is in effect on such day, as specified by the
Board of Governors of the Federal Reserve System (or any successor) for
determining the maximum aggregate reserve requirement (including all basis,
supplemental, marginal and other reserves) which is imposed on eurocurrency
liabilities.

                                       36
<PAGE>
 
         "Lien" shall mean any security interest, mortgage, pledge, lien, claim
          ----
on property, charge or encumbrance (including any conditional sale or other
title retention agreement), any lease in the nature thereof, and the filing of
or agreement to give any financing statement under the Uniform Commercial Code
of any jurisdiction.

         "Loan" shall have the meaning given such term in Paragraph 1(a) above.
          ----

         "Loan Request" shall mean a request for a Loan conveyed to the Lender
          ------------
from a duly authorized officer of the Company, with such request to be confirmed
in writing upon the request of the Lender.

         "Maturity Date" shall mean the earlier of:  (a) _________, 1998 
          -------------
[364 DAYS FROM CLOSING] as such date may be extended from time to time in
writing by the Lender, in its sole discretion, and (b) the date the Lender
terminates its obligation to make further Loans pursuant to the provisions
hereof.
                                                                         
         "Mortgage-Backed Security" shall mean (a) any security (including,
          ------------------------
without limitation, a participation certificate) that represents an interest in
a pool of mortgages, deeds of trusts or other instruments creating a Lien on
Property which is improved by a completed single family residence, including but
not limited to a condominium, planned unit development or townhouse.

         "Mortgage Loan" shall mean a residential real estate secured loan, 
          -------------
including, without limitation: (a) a promissory note, any reformation thereof
and related deed of trust (or mortgage) and security agreement; (b) all
guaranties and insurance policies, including, without limitation, all mortgage
and title insurance policies and all fire and extended coverage insurance
policies and rights of the Company to return premiums or payments with respect
thereto; and (c) all right, title and interest of the Company in the Property
covered by said deed of trust (or mortgage).

         "Multi-Employer Plan" shall mean, as to the Company or any of its ERISA
          -------------------
Affiliates, a Plan of such Person which is a multiemployer plan as defined in
Section 4001(a)(3) of ERISA.

         "NFI Holding" shall mean NFI Holding Company, Inc., a _______
          -----------
corporation.

         "NFI Holding Delivery Date" shall mean the date on which NFI Holding
          -------------------------
shall have delivered to the Lender all of the items described in Paragraph 4(c)
above, which date shall be no later than thirty (30) days after the date of this
Agreement.

                                       37
<PAGE>
 
         "NFI Holding Guaranty" shall have the meaning given such term in
          --------------------
Paragraph 3(b)(2) above, as such instrument may be amended, extended or replaced
from time to time.

         "Non-A Paper" shall have the meaning set forth on Exhibit L attached
          -----------                                      ---------
hereto.

         "Note" shall mean have the meaning given such term in Paragraph 2(c)
          ----
hereof.

         "NovaStar Financial" shall mean NovaStar Financial, Inc., a Maryland 
          ------------------
corporation.

         "NovaStar Financial Guaranty" shall have the meaning given such term in
          ---------------------------
Paragraph 3(b)(1) above, as such instrument may be amended, extended or replaced
from time to time.

         "Obligations" shall mean any and all debts, obligations and liabilities
          -----------
of the Company to the Lender (whether now existing or hereafter arising,
voluntary or involuntary, whether or not jointly owed with others, direct or
indirect, absolute or contingent, liquidated or unliquidated, and whether or not
from time to time decreased or extinguished and later increased, created or
incurred), arising out of or related to the Credit Documents.

         "Obligor" shall mean the Person or Persons obligated to pay the
          -------
Indebtedness which is the subject of a Mortgage Loan.

         "Participant" shall have the meaning given such term in Paragraph 9(h)
          -----------
above.

         "PBGC" shall mean the Pension Benefit Guaranty Corporation established
          ----
pursuant to Subtitle A of Title IV of ERISA and any successor thereto.

         "Permitted Other Debt" shall mean that Indebtedness described as
          --------------------
"Permitted Other Debt" on Exhibit I attached hereto.
                          ---------

         "Permitted Secured Debt" shall mean that Indebtedness which is the
          ----------------------
subject of a Lien and described as "Permitted Secured Debt" on Exhibit I
                                                               ---------
attached hereto.

         "Person" shall mean any corporation, natural person, firm, joint
          ------
venture, partnerships, trust, unincorporated organization or Governmental
Authority.

         "Plan" shall mean, as the Company or any of its ERISA Affiliates, any
          ----
pension plan that is covered by Title IV of ERISA and in respect of which such
Person or a Commonly Controlled 

                                       38
<PAGE>
 
Entity of such Person is an "employer" as defined in Section 3(5) of ERISA.

         "Potential Default" shall mean an event which but for the lapse of time
          -----------------
or the giving of notice, or both, would constitute an Event of Default.

         "Proceeds" shall mean whatever is receivable or received when
          --------
Collateral or proceeds are sold, collected, exchanged or otherwise disposed of,
whether such disposition is voluntary or involuntary, and includes, without
limitation, all rights to payment, including return premiums, with respect to
any insurance relating thereto.

         "Property" shall mean the real property, including the improvements
          --------
thereon, and the personal property (tangible and intangible) which are
encumbered pursuant to a Mortgage Loan.

         "Reportable Event" shall mean a reportable event as defined in Title IV
          ----------------
of ERISA, except actions of general applicability by the Secretary of Labor
under Section 110 of ERISA.

         "Required Documents" shall mean for any Mortgage Loan those items
          ------------------
described on Exhibit J attached hereto.
             ---------

         "Required Equity" shall mean, with respect to NovaStar Financial and
          ---------------
its consolidated Subsidiaries, the sum of the dollar amounts calculated after
multiplying the amount shown on NovaStar Financial's most recent monthly balance
sheet (as reconciled and consolidated by the schedule referenced to in Paragraph
6(a) above) for each asset class set forth in the table below (or if such asset
class is owned by NovaStar Financial or a consolidated Subsidiary but is not
carried on the balance sheet of NovaStar Financial (as reconciled and
consolidated by the schedules referred to in Paragraph 6(a) above), the fair
market value thereof as calculated by the Company subject, however, to the
approval of the Lender which will not be unreasonably withheld) by the
percentage amounts set forth opposite such asset class in the table below:




                                                                   Percentage
Asset Class                                                        Multiplier
-----------                                                        ----------
                                                                
Cash                                                                       0%
                                                                   
Property, Plant and Equipment                                             50%
                                                                   
Intangible Assets                                                        100%
                                                                   
AAA-Rated Agency Issued Conventional ARM Mortgage-                 
Backed Securities                                                       4.75%


                                       39
<PAGE>
 



                                                                   Percentage
Asset Class                                                        Multiplier
-----------                                                        ----------
                                                                
AAA-Rated Agency Issued GNMA ARM Mortgage-Backed                        5.25%
Securities                                                                   
                                                                             
AAA-Rated Agency Issued Conventional 30 Year                            6.00%
Current Coupon Mortgage-Backed Securities                                    
                                                                             
AAA-Rated Agency Issued Conventional 30 Year                            6.50%
Discount Mortgage-Backed Securities                                          
                                                                             
AAA-Rated Agency Issued Conventional 30 Year                            4.50%
Premium Mortgage-Backed Securities                                           
                                                                             
AAA-Rated Agency Issued Conventional 15 Year                            5.50%
Current Coupon Mortgage-Backed Securities                                    
                                                                             
AAA-Rated Agency Issued Conventional Fixed Balloon                      5.00%
Mortgage-Backed Securities                                                   
                                                                             
AAA-Rated Private Label Short Term Mortgage-Backed                      6.20%
Securities                                                                   
                                                                             
AAA-Rated Private Label Medium Term Mortgage-Backed                     7.60%
Securities                                                                   
                                                                             
AAA-Rated Private Label Long Term Mortgage-Backed                       9.20%
Securities                                                                   
                                                                             
AA-Rated Private Label Short Term Mortgage-Backed                       6.40%
Securities                                                                   
                                                                             
AA-Rated Private Label Medium Term Mortgage-Backed                      8.00%
Securities                                                                   
                                                                             
AA-Rated Private Label Long Term Mortgage-Backed                        9.80% 
Securities                                                              

A-Rated Mortgage-Backed Securities                                        25%
                                                                          
BBB-Rated Mortgage-Backed Securities                                      25%
                                                                          
BB-Rated Mortgage-Backed Securities                                       50%
                                                                          
B-Rated Mortgage-Backed Securities                                        50%
                                                                          
Non-Rated Mortgage-Backed Securities                                      50%
                                                                          
Agency Issued "Principal Only" Mortgage-Backed Securities                 25%
                                                                          
Agency Issued "Interest Only" Mortgage-Backed Securities                  25%
                                                                          
Excess Cash Flows                                                         50%
                                                                          
Warehouse Mortgage Loans                                                   4%


                                       40
<PAGE>
 



                                                                   Percentage
Asset Class                                                        Multiplier
-----------                                                        ----------
                                                                
Servicing Agreements                                                      45%

Hedging Agreements                                                       100%

Other Receivables                                                         35%



         "Requirements of Law" shall mean, as to any Person, the Articles or
          -------------------
Certificate of Incorporation and Bylaws or other organizational or governing
documents of such Person, and any law, treaty, rule or regulation, or a final
and binding determination of an arbitrator or a determination of a court or
other Governmental Authority, in each case applicable to or binding upon such
Person or any of its property or to which such Person or any of its property is
subject.

         "Security Agreement" shall have the meaning given such term in
          ------------------
Paragraph 3(a) above, as the same may be amended, extended or replaced from time
to time.

         "Settlement Account" shall mean Account No. _____________ maintained 
          ------------------
in the name of the Lender at the Contact Office.

         "Shareholders Equity" shall mean the net worth of NovaStar Financial
          -------------------
and its consolidated Subsidiaries as determined in accordance with GAAP (or with
such non-GAAP principles as may be disclosed to and approved by Lender from time
to time).

         "Single Employer Plan" shall mean, as to the Company or any of its
          --------------------
ERISA Affiliates, any Plan of such Person which is not a Multiemployer Plan.

         "Subsidiary" shall mean any corporation, partnership or joint venture
          ----------
more than fifty percent (50%) of the stock or other ownership interest of which
having by the terms thereof ordinary voting power to elect the board of
directors, managers or trustees of such corporation, partnership or joint
venture (irrespective of whether or not at the time stock of any other class or
classes of such corporation, partnership or joint venture shall have or might
have voting power by reason of the happening of any contingency) shall, at the
time as of which any determination is being made, be owned, either directly or
through Subsidiaries.

         "Take-Out Commitment" with respect to any Mortgage Loan shall mean a
          -------------------
bona fide current, unused and unexpired whole loan commitment or forward sale
Mortgage Backed Security commitment issued in favor of and held by the Company
made by an Approved Investor, under which said Approved Investor agrees, prior
to the 

                                       41
<PAGE>
 
expiration thereof, upon the satisfaction of certain terms and conditions
therein, to purchase such Mortgage Loan or related Mortgage Backed Security at a
Take-Out Price, which commitment is not subject to any term or condition which
is not customary in commitments of like nature or which, in the reasonably
anticipated course of events, cannot be fully complied with prior to the
expiration thereof.

         "Take-Out Price" with respect to any Mortgage Loan shall mean the
          --------------
specified price to be paid for such Mortgage Loan under the applicable Take-Out
Commitment covering said Mortgage Loan.


         "Total Liabilities" shall mean total liabilities of NovaStar Financial
          -----------------
and its consolidated Subsidiaries determined in accordance with GAAP (or with
such non-GAAP principles as may be disclosed to and approved by Lender from time
to time).

         "Unit Collateral Value" shall mean, with respect to each Eligible
          ---------------------
Mortgage Loan contained in the Borrowing Base:

         (a)  If said Mortgage Loan is of the type described in the proviso to
subsection (d) of the definition of "Eligible Mortgage Loan," eighty percent
(80%) of the lesser of (1) the unpaid principal balance thereof at the time the
Mortgage Loan is included in the Borrowing Base; and (2) the Fair Market Value
thereof.

         (b)  For all other Mortgage Loans, ninety-eight percent (98%) of the
lesser of (1) the unpaid principal balance thereof at the time the Mortgage Loan
is included in the Borrowing Base; and (2) the Fair Market Value thereof.

         "VA" shall mean the Veterans Administration and any successor agency.
          --

         "Warehouse Related MBS" shall have the meaning given such term in the
          ---------------------
Security Agreement.

                                       42
<PAGE>
 
      IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
executed and sealed as of the day and year first above written.


                                       NOVASTAR MORTGAGE, INC., a
                                       Virginia corporation



                                       By
                                         -------------------------------------
                                       Name
                                           -----------------------------------
                                       Title
                                            ----------------------------------


                                       FIRST UNION NATIONAL BANK OF NORTH 
                                       CAROLINA, a national banking 
                                       association


                                       By
                                         -------------------------------------
                                       Name
                                           -----------------------------------
                                       Title
                                            ----------------------------------

                                                                        352784.5

                                       43
<PAGE>
 
                         LIST OF SCHEDULES AND EXHIBITS
                         ------------------------------



                     
Schedule I           Schedule of Addresses
                     
Schedule II          Approved Investors
                     
Exhibit A            Form of Promissory Note
                     
Exhibit B            Form of Security Agreement
                     
Exhibit C-1          Form of NovaStar Financial Guaranty
                     
Exhibit C-2          Form of NFI Holding Guaranty
                     
Exhibit D            Form of Legal Opinion of Counsel for the Company 
                     and NovaStar Financial
                     
Exhibit E            Litigation Schedule
                     
Exhibit F            Schedule of Additional Required Documents
                     
Exhibit G            Form of Borrowing Base Schedule
                     
Exhibit H            Form of Covenant Compliance Certificate
                     
Exhibit I            Schedule of Permitted Other Debt (Including 
                     Permitted Secured Debt)
                     
Exhibit J            Schedule of Required Documents
                     
Exhibit K            Form of Wet Funding Mortgage Loan Transmittal Form
                     
Exhibit L            Definitions of "A Paper" and "Non-A Paper"
                     
Exhibit M            Form of Hedging Report