Note Due Diligence Checklist

[Pat Lowry]

I am currently looking at various opportunities to invest in notes. As a newbie, I don't have a standard due diligence list to send as part of providing offers. Here is what I would think to ask for:

Copy of note and deed of trust document
Verification of payment history
Copy of HUD statement for original purchase
Statement verifying types and amount of improvements/rehabs completed
Copy of latest real estate tax bill
Copy of hazard insurance policy
Verification of title insurance

I am assuming it will be up to me to pay for the BPO appraisal. I'm am sure I missed a lot but would appreciate any thoughts/suggestions.

[Bill Gulley]

Pat Lowry, what kind of notes are you interested in, what to look for will depend on the note? Probably why you can't find a list is because there isn't one that covers all aspects. If the note is non-performing out of a bank your due diligencs will be different from buying a note granny has from the sale of her home.

BTW, ignore this spamming by Rusty. IMO Who the heck is that guy? #5 I think...... :)

[Pat Lowry]

Good point Bill and thanks for the spam warning. Yes, I think Rusty has a friend name Ed Butowsky (a well known investor who also has famous investor partners, B.O. Problem and Pat McGroin). Sorry, I just couldn't resist the bathroom humor.

For the most part, I am seeing opportunities that involve SFH, either owner occupied or investment property with tenant. In most cases, note holder is RE group that buys/fixes/sells to investor or owner occupant and is raising cash for othe projects. Only interested in performing notes with decent payment history.

[Bill Gulley]

Then add to your list the past of the borrower and look for any relationship between the rehabber and the buyer. Some can provide a loan and sell, put a buyer in, the buyer makes a few payments then defaults and stays as long as they can, then they move into the next deal, dumping the property. You property valuation will be an indication here to the salee price. These usually don't have an appraisal so your collateral assessment is critical.

If you are working with a rehabber, you might get involvedd in the note process and purchase at the closing table. DOing so may require a license, probably, so again, I'll suggest a broker to work with in the beginning.

You also left out loan compliance with current laws, if the SAFE Act applies, make sure the loan is created in compliance with applicable laws....

[Dion DePaoli]

As Bill stated to a certain extent depending on the origins of the note will direct a certain portion of the material you request. Some general feedback on your list:

Copy of Collateral File - mortgage/deed of trust, note, modifications, forbearance, title policy, assignment chain (if not recorded)

Copy of Credit File - Origination documents - includes 1003, disclosures, credit reports and HUD - these are not always present in institutional files, their absence does not negative your enforcement capacity.

Copy of Servicing File - payment history, servicing notes, etc

Copy of Legal File - foreclosure, bankruptcy (if present)

Property value through a BPO or similar report will be your responsibility. A seller might provide a dated report but there is no duty to do so. Taxes are also your responsibility to check, just look them up, most counties have a website to check.

As a function of due diligence on your own, you will want to purchase a title abstract and summary. This will show the the vested interest of the property, the seniority of the security instrument and other liens. Typically the report summary, depending on the vendor, has some other bells and whistles like legal description, property tax check, etc.

Property Insurance is typically kept by the mortgage servicer. Not too many sellers keep it, in file. You can use escrow balances as an indication of insurance and tax payments. You will still want to check taxes before you purchase in case the bill was not paid. Insurance on the other hand, is just a simple call to change the mortgagee clause. Typically when you board your loan with your servicer they will do all of this for you.

When conducting due diligence, there is a difference between original wet ink signatures and copies. You may do due diligence on copies, but you are intend to purchase originals. That said, some originals have been lost and that is not the end of the world. The loss of a mortgage can be cured by getting a Certified Copy from the recording office. The loss of a note can be evidenced by a Lost Note Affidavit. When you settle the trade, you will want to ensure you understand how you are going to get the original files. Some sellers keep their files with a Custodian, such as a bank, in a vault. Also, many trades are payment then delivery of files.

A hot button will be the Assignment of Mortgage chain of ownership. This chain needs to be complete from the originator to the seller. Sometimes the chains are not all recorded and they sit in file, although that practice is less and less prevalent today. The chain can be verified by in-file documents and the title report you purchase. The chain needs to be perfect from start to finish. That is not to say, if the chain is broken it can not be fixed but likely a situation as a newbie you should avoid.

Other features will be file specific. If the loan has been modified, then there needs to be a modification in file. Sometimes these are recorded. If the loan is in forbearance, the agreement needs to be in file. If there is legal proceedings such as foreclosure or bankruptcy you will want to ask for the those related documents.

If the loan was originated privately, for instance by a property owner. You will want to make sure the loan was originated in consideration of SAFE Act for both the state where the property is located and the federal guidelines. Some states do not allow homeowners to originate. In that case you would want evidence the loan was originated by a licensee or attorney.

The part you listed about improvements and rehabs. You are confusing being a mortgagee with being a property owner. A homeowner can improve his house all he wants and has not duty to report any of the improvements or costs to the mortgagee. This is just a simple function of getting the property value report by way of a BPO or drive by appraisal, etc to see what the value of the property is. If you have the original appraisal or a dated BPO the comparison of the two reports will show improvements. Mind you, you have no right to enter the property to inspect for the purpose of the BPO. Those are all exterior inspections.

Further, you have no right to make contact with the borrower until you are the owner. In most cases, it will be expressly forbidden for you to make contact in any manner with a borrower before you own the loan.

If an updated credit report is not present or as a function of due diligence you may want either a new/updated report or a report in general. This would be another vendor service you would have to purchase.

There are lots of folks who have their opinions about whey they desire in a file, that is not the same as what is needed in a file to protect the enforceability of the note and security instrument. For the most part, the collateral file documents should all be present all the time. The rest is not a requirement. Many institutional sellers do not have pretty files. More often than not, there is nothing in the credit portion of the file.

On the other hand, some private originators may not have all of the origination documents since they are not too accustom to writing loans. So GFE's and TILA's and other disclosures might not be present. You will need to know what is required and what is desired. There is a lot to learn and a lot to know. Continue to ask questions.

Welcome to the business.

[Pat Lowry]

Thank you Dion. That's great information. I am working with brokers but wanted to get started in compiling my own list.

[Mike Mitchell]

Pat,
The most important thing on the checklist is the Deed of Humor and you have that! Thanks for the levity.

[Jason S.]

Assignment chain is critical. This includes that each assignment was properly executed. There was a recent appellate case (I forget which state) where a judge would not honor an assignment because the signatures were not perfect. Something small like Joe vs. Joseph. Buyer beware.

[Michael B.]

You mention the BPO, but to me this is the critical piece so I'll reiterate the importance. Make sure you understand the value of the house.

Way too often owner financing becomes a tool to get an inflated price for the property. An owner can't sell it for "what it's worth" so he finances the property to get the higher price. That way a bad appraisal at sale time won't screw the deal, and there's room to take a discount on the note to get cash.

But the true value has to be tied to what creditworthy buyers are willing to pay with bank loans on comparable houses in the area. Make sure you understand what you can sell the property for under these conditions.

[Cody Krecicki]

Buying my first note as we speak. Thanks for the information. Copy and pasting a lot of it over.

[Gabriel P.]

This is a very informative thread! I appreciate everyone's input!!

[Robert Baines]

Very good stuff. Thanks.