Two years ago, California’s Bureau of Real Estate (formerly the Department of Real Estate) put together a compendium of the seven most important facts that beginners who want to become trust deed investors in California should know. The document was stamped by the Governor of the time, Edmund G. Brown, Anna Cabellero, the secretary of the Business, Consumer Services and Housing Agency, and Wayne Bell Commissioner of the Bureau of Real Estate.
This is the first part of the series and covers the first four of these seven pieces of advice.
Seven essential elements of trust deed investments (Points 1-4)
- Who is the loan broker – The mortgage loan broker (MLB) is the one who helps you in making or arranging loans. The Bureau advises that before you hire an MLB make sure to do three things: call the California’s Bureau of Real Estate (CalBRE) to see if he or she is properly licensed, the length of the license and whether the MLB has been disciplined for any reason. You may also want to check the local Better Business Bureau to ask if any complaints have been lodged.
Secondly, check to see whether the MLB is related to the lender in any form or manner. This is called self-dealing and may harm the transaction.
Thirdly, ask the MLB to provide a professional profile. He should also tell you the approximate number and percentage of loans that he negotiated which resulted in foreclosure during the past few years.
- Market value and equity of the property and the security for your loan – You’ll need to have an accurate estimation of the market value of the property before you proceed. This may be the only way to recover your investment if the borrower defaults. Your loan-to-value ratio will also be calculated on the basis of this market value.
The market value is best calculated by hiring, or recruiting an experienced analyst to appraise the property for you. You’ll need to get a comparative estimation and know, too, the approximation of real estate prices in the neighborhood as well as the intrinsic value of the property.
As regards the loan-to-value calculation, the ratio is calculated by adding the total loans against the Property, including your loan, and dividing that by the market value of the Property. For example, if your borrower has a first deed of trust that is $25,000.00 and is requesting a second deed of trust of $40,000.00 and the Property is valued at $100,000.00, the loan-to-value ratio is 65% ($25,000.00 + $40,000.00 divided by $100,000.00 = 65%).
The lower the loan-to-value ratio is and the greater the borrower’s equity, the more likely the borrower will be driven to repay your loan. If he defaults, the property may make your investment worthwhile. If your loan exceeds the value of the property, you’ll know to hop out as quickly as possible at the outset or, better still, not to enter this proposition at all!
The preliminary report will give you part of this information about how valuable the property is.
The preliminary report (PRELIM) is prepared by a title company and is the doc. given you by the broker. It is an offer to insure and it provides you with various information about the property. When reviewing it, be alert to various problems which might affect the market value and equity of the Property and the security for your loan.
You may also want to keep in mind the following factors: that the borrower is the owner of the property; that there is a difference between the assessed and appraised value; the location of the property (whether it is private, public, or unusually situated); and whether the holder has delinquent taxes, assessments, or association dues. For other considerations see the doc. ‘Trust deed investments: what you should know’ that was prepared by the CBRE.
California’s Bureau of Real Estate advises that you ask your broker to provide an amended and current PRELIM dated as closely as possible to your commitment to fund a loan or purchase a promissory note.
- Borrower’s financial standing and creditworthiness – Borrower has to have both the ‘capacity’ and ‘desire’ to make repayments.
The borrower’s capacity is measured by: income; job position and stability; and overall financial standing, including assets, liabilities, and net worth, and any profit or losses incurred as the result of any business or investment activity.
The desire to repay is based on the borrower’s past performance in handling credit. To know that, you may want to review:
(1) Credit report; (2) Reports providing payment history on existing loans, including the number of late payments (loan status reports); and (3) Credit references.
When considering the borrower’s capacity and desire to repay, you should ask whether the borrower has, immediately preceding the request for the loan, borrowed a substantial amount of money. If he has indeed done so this may indicate that he is currently experiencing financial difficulties and should serve as a red flag to you. Extensive borrowing, too, may make it more difficult for him to meet his commitment to repay.
- Escrow process involving the funding of the loan or the purchase of the promissory note – The funding of the loan or transaction of the ‘promissory note’ is handled through an ‘escrow’. the escrow consists of all relevant money, documents, instruments, and written instructions and is conditionally delivered by broker, lender and borrower to an escrow agent.
The escrow instructions outline the conditions which must be satisfied or waived before the escrow agent gives your money to either the borrower or the Trustee. These conditions include, but are not limited to: (1) removal of certain liens; (2) payment of delinquent taxes; (3) execution and delivery of the promissory note and deed of trust; (4) selection of title insurance coverage; and (5) recording of the deed of trust or assignment of deed of trust that is accompanied with the loan according to escrow instructions.
The escrow should reiterate the same terms and directions as those of the promissory note and the deed of trust. You should also receive an oral preview of the escrow before you receive it. Furthermore, upon receiving it ensure that all terms and titles are clearly and correctly outlined and described.
The escrow should say that the promissory note and deed of trust should be delivered to you or an independent custodian on your behalf at the close of escrow. The broker usually does this.
All escrow agents are licensed by the Department of Business Oversight (DBO). The agent should be neutral and, therefore, it is better than someone other than the broker should obtain this job. He certainly should not be the Trustee, borrower, or a person related to the borrower.
The escrow “closes” when all the conditions of the escrow instructions have been waived or satisfied, the instruments have been recorded, and the funds have been disbursed.
It may help you to see ‘Trust deed investments: what you should know’ for conditions and details of this escrow.