Many banks and investors are trying to buy loans from other institutions or are considering selling the loans they currently hold as the economy struggles.
Loans are traded for a variety of purposes. The seller’s circumstances, rather than the note or the borrower, are usually at the heart of the explanation. Loans are typically sold for various reasons, including, but not limited to, the need for immediate cash, the dissolution of a partnership, a change in financial circumstances, a decline in the value of the underlying collateral, or a borrower’s default.
In many cases, buyers and brokers can get a better return on investment (Yield) by purchasing loans at a discount to the principal balance than they would by originating a new loan. The borrower’s creditworthiness, the reliability of the borrower’s payment history, the quality of the collateral backing the loan, and the reliability of any guarantors should all be taken into account by buyers and their brokers before committing to purchasing a note.
Individual loans and loan pools are also available for purchase. Loan purchases and sales follow a similar procedure but are governed by various legal agreements. I’ll call it a loan asset transaction to keep things simple. Both “loan sale” and “note sale” will be used synonymously throughout this article.
The buy and sale process is straightforward in principle, but, as with any deal, the devil is in the details. Here we’ll go over the eight main phases of buying or selling loan assets, along with the most prevalent dangers you should watch out for.
First, sign a non-disclosure and confidentiality agreement.
To ensure the safety of everybody involved, a non-disclosure agreement is typically signed. In most lending transactions, both parties exchange private information about the borrowers and must commit to keeping that data secure.
Step 2: Present a Proposal
Submit a written bid for the collateral backing the loan. Consult a lawyer with experience with loan buy and sell agreements so you can be guided through the process. The nuances of this agreement are worthy of their article, but that’s for another time.
Thirdly, make an open title deposit and show good faith.
The seller typically provides a good faith deposit to initiate the process. However, this might be negotiated. Compiling the loan documents takes time and effort, so you should only do it if you’re dealing with a serious bidder. You should also ensure the buyer has the necessary financial resources and won’t try to “raise the funds” after reviewing your documents.
The seller should start a title policy after getting the down payment. In most cases, the seller can purchase an ALTA assignment endorsement (10.6-06) to guarantee the new buyer’s rights to the assigned property and any liens against it. The endorsement is highly recommended if the option is available because it costs far less than traditional title insurance coverage.
Fourth, do your research.
When a down payment is made, it’s time to investigate the loan’s collateral. The number of assets you buy, and the type of asset they are, will affect how thorough your due diligence needs to be. Most buyers will get a new valuation, re-evaluate the loan, and check the loan’s paperwork, including the original promissory note and any correspondence between the borrower, the trustee, and anybody else involved in the loan.
Independent due diligence on loan assets can be performed by several organizations for around $250 per loan, depending on the level of appraisal and underwriting required.
During the offer negotiation process, you and the loan seller might discuss whether or not you will be allowed to examine the property’s interior or speak with the borrower.
Step 5: Put Pen to Paper
Transferring a loan’s ownership involves signing two more documents in addition to the buy and selling agreement. The first is an assignment, a notarized document recording in the county where the real property securing the note is located and referencing the original mortgage or deed of trust.
Promissory note number two is an authorized signature change. In the same way that a check is supported when it is signed over to a third party, a note can be supported by typing the appropriate language on the note’s reverse (for example, “Pay to the order of…”). If there isn’t enough room on the back of the Note, you can still endorse it by attaching an Allonge that contains the same language as what would go there. The Allonge must be permanently affixed to the original promissory note and kept together at all times.
An Allonge might contain wording like this:
THAT CERTAIN PROMISSORY NOTE, dated Month, Day, Year, made by Borrower Name Here, in favor of ABC Company, as payee, in the original principal amount of $x, xxx, xxx, is thus endorsed as follows and constitutes a part thereof by this ENDORSEMENT. With the same force and effect as if set down at the end of such Note, this Note is being transferred by the following Endorsement:
Without recourse, I hereby endorse and assign to ABC Loan Buying Company THIS PROMISSORY NOTE.
REMIT PAYMENT TO:
Loan Purchasing Agency ABC
__________________________________
Seller
Documents must be recorded in Step 6.
Finally, you’ll want to hand over the notarized assignment to the title firm so they may file it with the appropriate authorities and issue the policy called for in the title instructions and preliminary title report.
Step 7: Make a Currency Swap
Money can be transferred after the title company verifies the document’s recording. Escrow services and attorney trust funds are two options for this.
Eighth, Inform the Debtor
Once the financial transaction is finalized, you must comply with any applicable legislation requiring you to inform the borrower of the new loan servicer. Not all sales result in a switch in maintenance, and residential and commercial sales are governed by various rules. A “goodbye” letter detailing the loan servicer’s decision to cease serving the loan and the new payment address is provided by the outgoing loan servicer. The new loan servicer then sends a “hello” letter to the borrower, in which they introduce themselves, supply all necessary contact information, and detail where payments should be sent.
Even though a loan purchase and sell transaction includes eight steps, there are many potential dangers along the way.
Guarantees and Representations
If one party gives misleading information, the loan is fundamentally different; the transaction is fraudulent, etc., the agreement typically includes representations and warranties that provide specific remedies (such as credit, loan buyback, etc.).
Remember that the credibility of the guarantee-making party depends on that party alone. There is always the risk that a business, no matter how huge, won’t be around once a transaction has been finalized. It’s possible that, even if the bank survives, getting your money back will involve protracted legal battles. Problems can be avoided if sufficient due diligence is performed before closing the deal. Notify the seller if you need clarification on a crucial point of the transaction or if you want out of the value entirely.
Titling Procedures
In a loan acquisition, the chain of title can be a thorny issue. Since specific notes may have changed hands multiple times before, any discrepancies in vesting between assignments or transfers may be highly challenging, if not impossible, to rectify. It is typical for parties to receive grants but forget to record them, leading to gaps in the vesting chain. On the other hand, a vesting gap may exist if a party gets an assignment, transfers funds, and subsequently learns that the license issued is unrecordable for any number of reasons or simply because an error goes undiscovered.
A title policy or assignment endorsement is a wise precaution to take, but keep in mind that the policy will only pay out if you suffer a loss, not if you simply find out that anything is wrong. Consider this possible delayed title recovery scenario: The borrower stops paying payments shortly after the buyer purchases a second lien. When a lienholder initiates foreclosure, the trustee may choose not to follow through if they find a “vesting gap” in the chain of assignments. Until the junior lienholder technically incurs a loss on the policy, the borrower must continue making payments on the senior lien, and the junior lienholder cannot foreclose or collect on a title claim. If the borrower keeps making payments on the senior lien, you won’t lose anything until the senior lien forecloses out of your position.
Get a copy of the initial mortgage or trust deed and copies of any recorded assignments, and review them thoroughly to ensure a clean chain of title.
Land Taxes
Before purchasing the note, you can verify that the property taxes are current by accessing the relevant taxing authority’s online database. Take note of the county’s tax auction processes if the property taxes are past due, and then decide if you want to proceed with the note acquisition.
Youthful Liens
Confirming that the senior lien is still in good standing before purchasing a junior lien is important. Know your options for getting the senior lien reinstated in the state where the loan is recorded if it is delinquent. To avoid losing their position in a trustee sale, junior lienholders in some states must either pay off senior liens or reinstate them.
See if the promissory note securing the senior lien contains any restrictions on the placement of a junior lien. Obtain the document allowing the borrower to obtain the junior lien if obtaining a junior lien is forbidden.
If possible, you should get your hands on the senior lien holder’s promissory note. This information is not always readily available because promissory notes are not public records. Check for any modifications to interest rates, balloon payments, or other provisions that could negatively impact your junior status if you acquire such a document.
Indemnity Agreement
Affidavits of Lost Notes are joint in loan sales because the original promissory note cannot be retrieved. Although Affidavits were adequate for continuing foreclosures until recently, many judges now require the actual promissory letter to approve a foreclosure. Once you have obtained the original message, it should be stored securely away from harm.
Credit Analysis
The initial underwriting of many loans was flawed. The magnitude of the mistake may vary with the kind of loan involved. If the APR in the borrower disclosures for a home loan is incorrect by more than.One percentage points, for instance, the borrower may be allowed to cancel the deal. The loan should be re-underwritten as though it were a brand new one, with particular attention paid to the timing of all disclosures and the specifics of any cancellation rights that may apply.
Verification of Loan Terms from a Third Party
Sending the borrower an Estoppel Certificate is a brilliant idea if doing so is permitted by the conditions of your loan arrangement. The loan Estoppel Certificate is a legal document that requires the borrower to verify the loan’s specifics, including the principal sum, interest rate, payment schedule, and due date. Checking the borrower’s understanding of the loan terms independently helps prevent future headaches.
Loan-Seeker Coordination
Borrowers may be reluctant to make payments to the new note owner if they have doubts about the legitimacy of the sale, particularly in private, non-bank note sale transactions.
Note sellers should have a plan in place in case they receive payments soon after the deal closes, as this could lead to borrower uncertainty. You should have a letter from the note seller to the note buyer verifying the transaction, in addition to the standard “goodbye” letter, and make sure the note seller is willing to talk with the borrower if necessary to confirm the sale transaction.
Although buying and selling loan assets is a specialized transaction, like any other aspect of business, proficiency may be improved by repetition. Use seasoned advice and spend extra time researching before purchasing or selling notes for the first time, and you’ll be rewarded with larger returns and fewer unpleasant shocks.
Martin Goodman created the online marketplace for advertising residential and commercial mortgages and other loan assets under the domain name http://www.LoanMLS.com, of which he serves as president. His email is mgoodman@loanmls.com, in case you need to get in touch.
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