The 7 biggest dangers when investing in mortgages and what you must know to protect your investments today!
7 Dangers you should never make when investing:
(1) Never close a loan without title insurance or without an up to date hazard insurance policy in effect listing you or your entity as loss payee. A clear title is important when investing because the title is what gives you ownership of a property. Imagine investing in a home, closing the deal, then realizing the previous owner hadn’t paid property taxes for several years. Those taxes remain against the property and, as the new owner, you are responsible.
The taxing entity could even take your home. Or, perhaps two sales ago someone sold the home without getting the signature of an estranged husband who now wants to stake his claim. Perhaps, the previous owner didn’t pay a contractor for some work on the home and the company put a lien against the house. Or, the power company shows up with a crew to take advantage of an easement through your new backyard. The scenarios are endless and tracking down every last possibility is more than you can practically do on your own. That’s where title insurance comes in.
(2) Never close a loan leaving property taxes unpaid and we recommend if the borrower is behind on taxes at the time of the loan you should escrow 1/12 of taxes each month and collect with monthly payment.
All states have laws that permit counties to place a lien on properties with delinquent taxes. Under most state statutes, tax liens are granted the first-lien status and are superior over other liens regardless of whether the mortgage was recorded before or after the tax lien.
Once the property taxes are delinquent for a long time, the taxing authority will initiate a tax sale. A list is recorded in the county records that name the taxpayer, the property, as well as the amount of tax due, and the list will often be published. The taxpayer will receive some form of notice of the tax sale, but in most jurisdictions, no judicial action is required.
(3) Never lend on the property for which labor and/or materials have been provided within 90 days prior to closing without either (a) having an extended ALTA policy of title insurance with no exception for labor and materials liens (difficult to get), or (b) having received a signed affidavit from the borrower which lists all providers used (along with contact info and the amount of any outstanding debt), and contacting all labor and materials providers on the list to make sure that none is preparing to file labor or materials liens.
(4) Never close a loan secured by property which appears to show (by inspection, general observation, public record, or known history) a reasonable possibility of being contaminated by any form of hazardous waste, unless you have been a current level I or level II environmental study showing the property to be clean. And in any event, always require borrowers to sign a hazardous waste indemnity agreement.
(5) On a construction, rehab, or development investing loans: never disburse funds for work that has not been completed (unless as a deposit to a company that has been carefully checked out and is considered to be highly credible) and never disburse funds directly to the borrower unless as reimbursement for work that has already been completed and paid for, and which is documented accordingly.
(6) Never lend 100% of the purchase price and repairs, this leaves you lending to a borrower with no skin in the game. If the property does not sell or renter stops paying you could be left having to foreclose. Now the borrower will tell you the loan to value is 65% so you have plenty of equity in case of default. This may be true but if you add in the cost and time of foreclosing and the discount you may need to offer to sell a property quickly. You could break even or possibly lose the principal. Our belief is that the borrowers must have skin in the project at all times we are lending to them.
(7) Never send monies to loan officer, mortgage broker or real estate agent for loan closing. All loans must close at title or escrow company and money only sent to title or escrow company.
Now, I am good at telling people what not to do when investing, so if anyone asks, I’ll gladly crank out another seven not-to-do items, or if you would like for me to expand on any particular item on the list, I will give that a shot as well. Any comments or suggestions are always welcome.