INVESTMENT PARAMETERS WHEN MAKING A PRIVATE MORTGAGE LOAN - PART 5
Market value and equity of the property and the security for your loanThe market value of the Property is critical to your decision to lend your funds or purchase a promissory note because there is a possibility that the only way to recover your investment is through the sale of the property. Therefore, the market value of the Property should be correctly estimated and the total loan-to-value ratio properly analyzed as illustrated below. This information should be made available to you before you commit your money to the transaction. A. Market Value: The sale price, the cost to build, or the value in use to a specific owner does not necessarily represent the market value of the property. A market value opinion requires consideration of comparable sales and other market data by a competent professional.The market value conclusion may be presented in the form of an appraisal report.While the borrower customarily pays for the cost of the appraisal report, you would usually retain the appraiser’s services to prepare the report, which should be reviewed by you in advance of funding the loan or purchasing the promissory note. You should make every effort to inspect the Property which will be the security for your investment. B. Loan-to-Value Ratio: The total loans against the Property, including your loan, divided by the market value of the Property determines the loan-to-value ratio. For example, if a borrower has a first deed of trust in the amount of $25,000.00 and is requesting a second deed of trust in the amount of $40,000.00 and no other liens will be placed against the Property, which 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 and the greater the borrower’s equity, the more incentive for the borrower to protect the equity in the property (i.e., sell or refinance the property if unable to make payments under your promissory note) or for a third-party bidder to purchase the property at a foreclosure sale. If the Property is over encumbered (the total loans or other liens exceed a reasonable loan-to-value ratio or exceed the market value), the Property will provide little or no security for your investment. A sufficient equity should be maintained in the Property to allow for the fees, costs, and expenses that you will incur in foreclosing if that becomes necessary.The borrower’s equity is not the same as the protective equity. The borrower’s equity is the difference between the market value of the property and the total indebtedness secured by the property. The protective equity is the difference between the market value of the Property and the total indebtedness of loans senior to your loan and your loan, but does not include loans junior to your loan. The existence of a lien junior to your loan will diminish the borrower’s equity, increase the borrower’s payments or debt service, and reduce the borrower’s ability to refinance. In the event of a default regarding senior loans (liens), beneficiaries who have a right of lien upon a property of another (lienors) and who are junior are entitled to protect their security interest in the Property by paying the borrower’s delinquencies on senior liens and/or by commencing their own foreclosure action. Therefore, junior lienors should keep informed of defaults in connection with senior loans (liens).
Comments