-What do need to do to protect ourselves in the case she does not pay-up?  

Data Protection Again, chattel lenders are very small in relation to mortgage operators.

I suppose if you were looking to abscond with the money of your friends, you could create an LLC, pay yourself an exorbitant salary and then fold up the tent when the investor funds run out ;)  Since you probably don't want to do that, just put together a good agreement that protects everyone.

Google the "tenants in foreclosure protection" as gar as CA state laws.  

PMI reimburses the lender if the borrower defaults on the mortgage so it protects the lender.

Protect your investment and fix the water and foundation problems.

Will that really protect myself from getting the deal stole from under me? 

There is some debate as to what is the best way to purchase the property to protect your personal assets.  

Yes, there is insurance coverage to help mitigate that, but that does not give nearly the amount of protection that an LLC provides.

They would not be considered a legitimate tenant in the eyes of the lender as the lease (Assuming you have one) is between the tenant and you, not the borrower so, the tenant would not be protected with any of the "Protecting tenants at Foreclosure" rules.