When a loan is made to a borrower in a real estate transaction when there is collateral involved, the loan is considered “secured” by the real estate asset. This means that if the borrower fails to repay the loan per the terms specified in the promissory note, the lender has the ability to collect their money by accessing the real estate collateral that is securing or backing the loan.
Unsecured loans such as money you lend to your friends and family are “keep your fingers crossed” loans. If the person you lend money to doesn’t repay you the money you lent them per the terms specified in your agreement (if you have one), then the lender typically doesn’t have recourse or collateral to collect to protect the money lent to borrower in terms of principal and interest.
At Legacy Capital, there are 8 steps we take to secure the loans we make to borrowers to protect our capital as well as our investors capital in addition to our underwriting process, which you can read in a blog post here: 8-steps-to-making-real-estate-loan-more-secure
We have outlined of few of these measures below:
- Promissory Note
A promissory note is a legal instrument in which the borrower promises in writing to pay a specified amount of money by specific dates to the lender. When a borrower signs a promissory note evidencing their promise to repay the loan, they also offer security in the form of real estate to “encourage” an approval in the form of a mortgage which attached the promissory note to the real estate asset.
A mortgage loan, also referred to as a mortgage, is used by lenders to put a lien on the property being mortgaged. The loan is “secured” on the borrower’s property. This means that a legal mechanism is put in place which allows the lender to take possession and sell the secured property (“foreclosure” or “repossession”) to pay off the loan in the event that the borrower defaults on the loan or otherwise fails to abide by its terms.
The mortgage is recorded at the county courthouse in which the property is located so that the property cannot be sold or refinanced without first paying off mortgage in the amount recorded to the lender. A title company will “pull title” to see if any liens or encumbrances are attached to property such as a mortgage and the title company will not give title insurance to new owner for “free and clear” title if the mortgage has not been satisfied.
The word mortgage is derived from a “Law French” term used by English lawyers in the Middle Ages meaning “death pledge”, and refers to the pledge ending (dying) when either the obligation is fulfilled or the property is taken through foreclosure
- Personal Guarantee
A personal guarantee is a promise made by a specific person, an organization or other entity such as a corporation or limited liability company; to be the guarantor and to accept responsibility in the event that the secured real estate loan is not repaid per the terms specified as part of promissory note.
The lender is more secure when a borrower signs a personal guarantee since the loan is now backed by the value of real estate asset as well as the LLC and individual person. Just like banks, Legacy Capital transfers the risk of loans defaulting from the lender to the borrower the use of legal documents such as personal guarantees. There is an even higher level of motivation to repay a loan when a borrower signs a personal guarantee as borrower’s personal assets are now pledged as collateral for loan repayment.
- Confession of Judgment
A confession of judgment is a written statement, which can be used as evidence in court, in which the borrower admits liability to another lender, accepts a quantification of damages and agrees that the judgment may be filed upon the occurrence of a stated condition (failure to repay loan as specified). The confession of judgment which borrowers sign prior to receiving funds from Legacy Capital cuts down the costs and timeframe to collect funds in the event that a borrower fails to repay loan according to terms agreed.
- Assignment of Rents & Leases
The Assignment of rents and leases is a document attached to a mortgage loan agreement which entitles the lender to any income (from leases, rents, etc.) derived from the property once the owner defaults on the loan. The borrower agrees ahead of time that the lender can collect any income generated from property if the borrower stops payment on loan.
- Property & Title Insurance Naming Legacy Capital as Loss Payee
Legacy Capital is named as Loss Payee on property insurance and title insurance for all properties prior to lending funds to a borrower. This means that if there is an incident where there is an insurance payout, Legacy capital gets repaid the full amount of money loaned prior to the borrower receiving any funds from an insurance payout.
- Independent 3rd Party Appraisal
Having a secured loan on a real estate asset is only as good as the asset being worth more than the loan amount. The banks got themselves into trouble during 2008 by making loans of 100% of the properties value (even more in some instances) because when property values dropped by 30%+, the property could not be sold for enough money to repay banks for the money lent.
At Legacy Capital, we utilize independent 3rd party licensed appraisers who give us a determination of value. We do not allow the borrower to tell us what the property is worth and we typically have a good idea of property values since we are familiar with neighborhoods in which we lend. As long as the property values do not fall by 40%, the real estate assets themselves will provide collateral to repay our loans in a worst-case scenario.
Using a lawyer or title company in all real estate transactions, Legacy Capital does not send money directly to a borrower, but rather uses a 3rd party to ensure that transaction is closed correctly before funds are released. This means that all legal documents are signed, insurance policies are in place and the escrow company facilitates the transaction by following the closing instructions letter that Legacy Capital prepares on each deal we fund.
If you would like to see examples of the legal documents we use with our borrowers to secure our real estate loans, just call us. Making secure real estate loans even more secure is something we take pride in.