HOW TO DOCUMENT YOUR NOTE AND LOAN FOR MAXIMUM VALUE

Once you and your buyer have agreed on terms for the loan, it needs to be documented properly and legally as part of the sale of your property.
New federal loan regulations known as Dodd-Frank began in 2014 and requires that you make a good-faith effort to confirm that the borrower can afford to pay back the loan you are giving them. The best way to do this is by requiring your borrower to fill completely out a 1003 Loan Application – just like a bank would do. They must list ALL of their debts and income, and assets – in general, the total of their monthly payments for all debts (including this new mortgage) should be less than 40% of their monthly income.

If you have specified a balloon in your loan terms, it is also very important to review their assets and their credit, to assure that borrower has sufficient assets to pay the balloon when it comes due (e.g. they have another house they are selling which has sufficient equity to pay off your loan) OR their credit history is strong enough to expect that they can refinance the balloon balance by the time it comes due.

The easiest way to make sure you have complied with these new federal loan regulations is to use a Licensed Mortgage Originator in the area of the property. Failure to comply with the regulations and to obtain income, asset and debt information from your borrower creates risk and reduces the value of your loan.

If you are transferring the Deed for property – you MUST insist on a promissory note AND a proper security document (Deed of Trust is preferable, or Mortgage is required in some states) – with a lender’s title insurance policy that insures that title has been completely and properly transferred to the new owner. The security document must be recorded during the sale and transfer of the property.

If your are keeping the Deed for the property until the borrower has paid off the loan, this is known as a Contract for Deed, Real Estate Contract or Land Contract. There are some advantages to this structure for you as a seller in case the loan is not paid – but these are considerably harder to sell and value is less than a conventional property loan – and are now illegal or cannot receive title insurance in some states. A title company in the area of the property can advise you.

It is generally advisable to have a promissory note signed along with the contract (And the contract should be recorded) and to also complete the title search, and obtain lender’s title insurance- this assures that you can properly and legally transfer the property to the buyer when their loan is paid off.

The Promissory Note is a critical document. It should state all of the following:

Payee – who is making the loan and will receive the payments
Maker(s) – persons responsible for making the payments
Interest Rate
Date on which interest begins
Frequency of Payments
Amount of each payment
Date when first payment is due
Maturity date (or Balloon Date)
Grace period – when is payment late, and late fee due – amount of fee
Default Rate – if payments are not made, and a default is declared, what Interest Rate will be charged (if not the original rate)
Reference to the type of security document that secures repayment of the loan

The Security document (Deed of Trust, Mortgage, or Contract) is the second critical document for your loan that pledges the property as collateral that can be foreclosed in case of non-payment of the loan. This is a lengthier document that spells out the other obligations of the loan, and what happens in case of non-payment. Some states also commonly use a “short form” deed of trust that references the long document with all the general provisions that was recorded previously and can be used in all loans and incorporated by reference. It is very important that the Security document is thorough and complete. Some frequent areas of mistake that should be checked are:

Reference to the Promissory note and date
Correct and complete identification of the property securing the Note
Correct identification of the Mortgagor (the buyer paying the loan)
Correct identification of the Mortgagee (the seller giving the loan)
Requirement for Buyer to make payments prescribed under the note, and pay taxes and insurance, and to name you as lien holder on the insurance for the property
Requirement for Buyer to pay all amounts due that are necessary to protect the property against other liens that can come ahead of the loan (e.g. assessments, condo fees, association dues in some locations)
Property Insurance Naming you as the Lien holder/Mortgagee – this is a VERY important part of the loan package that is often overlooked – and protects you and assures you will receive full value for the loan you gave borrower to buy your property. If the buildings burn down — and your are not named as Lien holder, on their insurance coverage — the borrower can receive the insurance payment directly and can walk away from the property and your loan — all you receive is the empty land/ compromised building.

You must also be named on the policy with your CURRENT notification address in order to receive notice of any non-renewal of the policy. If the borrower drops his insurance, and the property burns down, you have even less possibility to be paid off for your loan. If he borrower changes insurance companies, you also need to be notified of the lapse of old policy so you can require them to provide you a copy of the new insurance – and again you make sure that you are named as Lien holder.
While you can save a few dollars and “do it yourself” for these necessary documents, there is usually a considerable sum of money you are owed, and having the loan documents done right by a title company or attorney with all the provisions above, and more, protects you and is highly recommended. Having experts assist with the loan documents can avoid a number of pitfalls — some may be impossible to fix later — if you or your buyer are the ones who draft the documentation for the loan.

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