Written by Jeffrey R. Armstrong – President/Owner of Armstrong Capital
Your favorite Master Note Buyer – Straightforward, Honest, Fair…
Having your note purchase offer accepted is like getting that runner’s high during a marathon. But hold the Gatorade cooler – the note transaction isn’t closed just yet. During the 4-6 weeks (or so) between when your purchase offer is accepted and when the assignment is recorded (commonly referred to as the “due diligence” phase), there are many hurdles to overcome. If you stumble on any of them, the purchase may fall through and put you back at the starting line.
This summer, while things typically slow down a little in the note business, it may be a good time to brush up on your due diligence and processing skills. Just like an athlete trains for a race, you can train yourself for the daunting final steps in purchasing a note. Due diligence procedures vary from investor to investor, so here are some of the most common problems encountered during this due diligence phase, and what (if anything) can be done to prevent or mitigate them.
- The appraisal isn’t high enough. The note buyer will have the property appraised in order to protect its interest in the note. They want to make sure the property is worth at least as much as it sold for when the note was created so that, if foreclosure is in the future, investment and expenses can be recouped. If the appraisal comes in too low, the note buyer may lower the price they are paying for the note or cancel the transaction. Once in a while it may be possible to get a more favorable second opinion from a different appraiser. Sometimes the value will be fine but the appraisal reveals major defects, non-pride of ownership, etc. that will cause a note buyer to lose their warm and fuzzy feeling about the note and again cause them to lower their purchase price or cancel the transaction. Going back to renegotiate the price when the appraisal comes in low or unfavorable can potentially hold up the purchase process, delay your closing or stop the process altogether.
- The property is in a high-risk area and you, the note buyer, don’t want to live with that risk (or pay to insure against it). In states that require a natural hazard disclosure report, during due diligence you should receive a document outlining the natural hazards that may affect the home (floods, earthquakes, seismic hazards and fires, lava, for example). The note buyer may require that the payor purchase extra hazard insurance (above and beyond regular property hazard insurance), if the property is in a high-risk area, and that insurance can be expensive. The payor may not agree or want to cooperate. To prevent unpleasant surprises during due diligence, ask the note seller in the beginning if they are aware of any natural hazards that exist in the area of the property the note is secured by, what type of extra insurance might be needed and how much it might cost.
- The home isn’t insurable. If a previous property owner has made a major insurance claim on the property, such as water damage or a mold claim, this will show up in insurance records, and insurance companies may refuse to insure the property at all, thinking that it is too much of a risk. If a property is not insurable, a note buyer will be less likely to buy a note secured by the property, as note buyers usually require hazard insurance be maintained until the note is fully paid off.
- Credit is not acceptable. Depending on the note buyer acceptance of the payors credit can be a sticking point. Some note buyers must see a specific credit score in order for them to purchase the note. Others may have a more common sense approach and dig a little deeper as to why the credit scores are not what they seem. And still other note buyers can really care less about the credit score of the payors as long as there is enough protective equity above their purchase price for the note. Knowing your note buyers preferences and knowing your own preferences when it comes to the payors credit will help alleviate this issue becoming a sticking point.
- There are clouds on the title. During the due diligence process, the note buyer will usually hire a title company to do a title search and issue title insurance. The title search ensures that no one else has a legal claim to the property or the note we want to buy (such as the IRS, the state or a relative of the seller), and title insurance protects the note buyer against any future claims to the property. If there is some sort of lien or claim against the property or note, the issue will have to be resolved before the transaction can proceed.
- You, the note buyer, get cold feet or the seller backs out. The initial mortgage purchase agreement will outline justifiable reasons for either the note buyer or seller to back out without penalty, such as an unacceptable appraisal, unacceptable credit, not waiving a contingency or not meeting a deadline. However, if the note seller decides to back out simply because of a change of heart or because a better offer was made, you will have a right to collect damages from the seller, provided your initial mortgage purchase agreement states clearly what those damages might be.
- Errors prevent closing on time. There are many different parties involved in the due diligence process, and if any one of them makes a mistake, getting the note purchase transaction to closing can be delayed. Depending on what your initial purchase contract stipulates and whose fault the delay is there may be some concessions in order for wither the note seller or the note buyer. The seller could also refuse to extend the closing date and the whole transaction could fall through. In a best-case scenario, the seller could simply agree to extend the closing date with no penalty. After all, if the deal doesn’t close, the note seller will have to start all over again, too.
These are just some of the obstacles that may show up during the due diligence process of a note purchase transaction. As the summer unfolds and you find yourself with some extra time on your hands, brush up on your processing and due diligence skills so that you are better prepared for the surprises and hurdles that will inevitably show up in the future. Remember success demands action, keep on marketing, it’s going to work! TWITA! (That’s What I’m Talkin’ About!) J