Amerifunds'  Instablog

A security instrument accompanies (or should accompany) every Promissory Note. The security instrument is state specific, and examples include mortgage, deed of trust, security deed, or trust deed. The security instrument identifies and encumbers the real property used as collateral for the note. It is notarized and recorded with the county in which the property is located. Once recorded, it secures an interest in, or lien against, the property.

In title theory states, a mortgage is used and it conveys ownership to the lender. A clause in the mortgage provides that title reverts back to the borrower when the loan is paid. In lien theory states, the mortgage creates a lien only on the property and the title remains with the borrower. The lien is removed when all the payments have been made.

With a Deed of Trust there are three parties involved; the Trustor (borrower), the Beneficiary (lender or note holder), and the Trustee (third party holding title to the property, normally a title company or attorney). With a mortgage document, there are only two parties involved, the borrower and the lender. With a Deed of Trust, the borrower conveys title to a trustee who will hold title to the property for the benefit of the lender. The title remains in trust until the loan is paid.

Certain language is vital in a security instrument. When reviewing, look for the following terms:

Due on Sale Clause: This clause allows the (note holder, lender, etc.) to demand immediate payment of the note if the property is sold without their written consent. The purpose of the due on sale clause is to prevent an assumption of the debt by a higher-risk borrower on the note. Most investors will insist upon this clause being in the security instrument.

Charges; Liens: This section requires the borrower to pay all taxes, assessments, charges, fines, and impositions attributable to the property. Any violation constitutes default.

Property Insurance: The borrower is required to keep a current homeowner's insurance policy on the property at all times. This section determines the minimum coverage amounts, and allows the beneficiary to force-place insurance on the property if coverage lapses. Normally the beneficiary is allowed to collect interest (at the note rate) on any premium amounts advanced, and incorporate the premium as additional debt owed by the borrower. This section also requires the beneficiary to be named as the loss payee so that in the event of a loss, their security interest is protected.

Preservation, Maintenance, and Protection of the Property: Borrowers are required to maintain the property to prevent deterioration or a loss in value while they occupy it. If the property is damaged and insurance proceeds are advanced for repairs, the borrowers are responsible for the repairs even though the beneficiary controls the release of the funds. Most importantly, this clause allows the beneficiary, upon giving proper notice, to inspect the property to insure it is being adequately maintained and their interest is being safeguarded.

Loan Charges: This section allows the beneficiary to charge any fees incurred during the default/foreclosure process, including attorney's fees, property inspection costs, and valuation fees.

Hazardous Substances: Borrower is prohibited from allowing the presence, use, disposal, storage, or release of any hazardous substances. Examples include gasoline, kerosene, other flammable or toxic petroleum products, toxic pesticides and herbicides, volatile solvents, materials containing asbestos or formaldehyde, and radioactive materials.

Pay attention to the verbiage in the Security Instrument; your investor certainly will!

Due diligence generally refers to the care a reasonable person (or company) should take before entering into an agreement or a transaction with another party. When dealing in the arena of private notes, the terms due diligence and underwriting are used interchangeably. To note brokers, it's often seen as the barrier between them and their commission check.

A broker should be the helping hand when an investor is proceeding with due diligence. Too many times the broker sees investor requirements as unnecessary and senseless. They grumble at having to chase down this document or that pay history for the investor. Then again, their only investment in the transaction is a fee that only gets paid when the investor is satisfied the deal passes muster.

Granted, some investors' requirements can seem unrealistic. Getting back to the Golden Rule (He Who Has the Gold Makes the Rules), you can either abide by their processes or take your business elsewhere. You can minimize the headaches caused by the due diligence process by being proactive and doing these things:

· Create a due diligence checklist. Provide this checklist to your note seller once they have agreed to a price and are ready to move forward. This checklist can be customized based on your different investors and their requirements.

· Explain the process to your sellers. Set their expectations early in your communications that due diligence takes time, and no money will trade hands until the investor is completely satisfied there are no 'smoking guns.'

· Bring the seller along with you. Show them you want this deal to close as quickly as they do. Having a common goal and a mutual timeline will prompt them to supply whatever is needed to move closer to the funding table.

· Put the file together yourself. Collect as many items from the due diligence checklist as possible before sending the file to the investor for underwriting. Constantly faxing & e-mailing follow-up documentation creates chaos, and the investor will quickly tire of trying to match everything up with what has already been supplied.

· Respect the investor's decision. It is not your money buying the note. You are in no position to determine what is and isn't reasonable. Besides, having that investor make good underwriting decisions benefits you in the long term, because they're still there to buy your notes two, five, even ten years down the road.

The quality of due diligence is generally the difference between companies that are profitable long-term and those that are flash-in-the-pan; here today, gone tomorrow. Try to see your investors as your partners and not your adversaries. You'll both be the better for it.