Let’s say you found a note that you think you like. It meets all of your criteria, it’s in the right lien position, and it has the right loan to value (LTV) and fair market value (FMV). The numbers look good.
You got a good price, and you stand to make a respectable return. You feel that you’ve done your due diligence. But how in depth was your due diligence?
Trust and Verify
Obviously, buying notes (or anything else, for that matter) is a “trust but verify” situation. By that, I mean you can take whatever the seller tells you at face value, and then that’s about it. Face value. Now you have to verify everything from your note seller to the collateral to the note stats.
Maybe you already know the seller, but then again, maybe you don’t. Have you asked around to see if others have done business with them? Maybe you need to do a background check or put other safeguards in place. Perhaps you can have the document custodian run an exception report to verify that all the collateral is there. An initial step would at least be to see what’s available electronically.
Hopefully, you’ve already reviewed your note sale agreement (NSA) to see that all the provisions are acceptable to you. Depending on what checks out, you’re probably ready to fund. If you’re still skeptical of the note seller, perhaps you can use a bailee letter or even an escrow agent.
But let’s say you funded. Now what do you expect next?
In the old days, the servicing transfer was pretty easy. It was pretty much the Wild West. Today, there’s much more compliance involved, especially with borrower data at the time of transfer. This is one of the many reasons why I strongly recommend using a licensed servicer in the state of the loan.
In fact, to give you an idea of how serious this is today, my firm PPR will not sell a note to a buyer unless they are placing it with a licensed servicer. In other words, we’d rather have the deal fall through than to take on the liability. You see, with the current regulations, we’re now liable for who we sell or transfer that data to.
Related: The 8 Non-Negotiable Habits of a Successful Note Investor
The next part of the process is the shipment of the collateral to the new note owner or their document custodian. This part of the process falls under document management.
If your docs go to a document management company (like a Richmond Monroe or Orion Financial), it’s pretty straightforward to get them to run an exception report—or in other words, to do document inventory to see what is or is not in the collateral file.
If for some reason something is missing, you can refer back to the provisions and timelines in your NSA. Then, you can reach out to the note seller to see if they can assist. If all else fails, you can get a document retrieval company to try to obtain the missing documents.
If the documents are coming directly to you, it’s pretty much the same process, except that you’re doing the inventory procedure to see if anything is missing. If there is, you’re pretty much doing the same things that I referenced above.
So, What Needs to Be There?
This an interesting question because you’ll get different answers, especially from different note gurus (primarily in the seller financed world). And I get it—the more pristine the paper, the more valuable the notes. In fact, some folks make it part of their business model to clean up the collateral files and then mark up the assets. These types of folks like to see everything under the sun in the file, such as the original loan applications, title policies, and/or insurance policies. But realistically, do they need to be there? The answer is no. In fact, many of these types of documents can be acquired for a nominal fee from a document retrieval company, as long as one is willing to wait.
But in the nonperforming note world, especially with junior liens, many of these things are just plain missing. So, what should be in a loan file? Well, for me, it’s whatever documents are required in that state in the event I would need to foreclose.
This can actually vary pretty dramatically, so you may want to check with your foreclosure counsel in whatever state you’re buying your nonperforming note in. For example, only a handful of states require an allonge chain. This is a chain of note owners. On the other hand, an assignment of mortgage (AOM) chain is pretty much required everywhere.
Keep in mind, although these two document chains are preferred to be complete, there are valid situations where they will not necessarily be in sync.
If the note is sold between banks or members of MERS, the assignments are transferred electronically within that system. If the note is then sold to someone who is not a member of MERS, it would be a paper assignment that would need to be recorded at the county courthouse. Therefore, only the recorded paper assignments would make it into the file, thus making it impossible to match the assignment chain with the allonge chain.
The note and mortgage are comprised of two legal documents: the financial instrument (note/line of credit) and a security instrument (mortgage/deed of trust). Both documents have their own methods of endorsement: the endorsement of a note (often referred to as an allonge) and the assignment of mortgage. Both are legal documents that can exist without the other.
Another example is if a more superior lien forecloses and there is no equity to protect your lien’s position. In this case, security instrument is extinguished, but the financial instrument stays intact.
In in the event of a chapter 7 discharge, the financial instrument is extinguished, but the security instrument stays intact.
Their exclusivity is the reason why each needs to have their own chain of title and is also the reason why chains of title do not necessarily need to match—because in some cases, they simply cannot.
Sometimes the owner of the loan and the servicer are different entities. However, there are situations when the owner needs to assign the mortgage to the servicer for purposes of enforcing the security instrument. You would not, for example, want to also make the servicer the beneficiary of the note. This is a common cause for the chains of title not matching.
Lastly, situations exist where pieces of the chain are missing or were never executed. Sometimes, the entities involved cannot be contacted or have been dissolved. It is common practice while curing collateral issues to skip over unobtainable pieces, as long as a clear chain of title can be made from the originator to the present beneficiary.
As for the basic documents, such as the mortgage, the note, the assignments, and the allonge chains, it’s great to at least attempt to have these basics in the file. However, it is often fixable if any of these documents are missing.
A mortgage, for example, is public record, and a duplicate can easily be had. An assignment or allonge can often be retrieved, or a lost assignment or allonge affidavit can be created. You can even create a lost note affidavit, but in some jurisdictions, this may make it difficult to foreclose, so you would need to check with your foreclosure counsel in that particular state.
As you can see, these are some of the things to know and check on once you bought a note. So, if you’re new, it may make sense to know your note seller, check your contracts, use a document custodian, and by all means, use a licensed servicer and foreclosure attorney in the same state as the note you’re buying.
What are your thoughts on this topic?
Happy investing and let me know of anything else you look out for after buying a note.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.